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NATURE OF FACTORING

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<strong>NATURE</strong> <strong>OF</strong> <strong>FACTORING</strong><br />

www.factors-chain.com/home<br />

www.factoring.org<br />

2009


A US DEFINITION:<br />

• “a continuing arrangement between a factoring<br />

concern and the seller of goods or services on<br />

open account, pursuant to which the factor<br />

performs the following services with respect to<br />

the accounts receivable…”<br />

1. Purchases all accounts receivable for immediate<br />

cash [Transfer of ownership; right to receive<br />

payment under law]<br />

<br />

Finance<br />

2. Maintains the ledgers and performs other bookkeeping<br />

duties<br />

<br />

Admin<br />

3. Collects the accounts receivable<br />

4. Assumes losses which may arise from the<br />

customer's non-payment<br />

<br />

<br />

Admin<br />

Bad debt<br />

protection<br />

2009


UNIDROIT CONVENTION ON INTERNATIONAL <strong>FACTORING</strong><br />

International Institute for the Unification of Private Law (Rome)<br />

• DEFINITION: ANY 2 OUT <strong>OF</strong> THE FOLLOWING 4:<br />

1. finance for the supplier, including loans and advance<br />

payments<br />

2. maintenance of accounts (ledgering) relating to the<br />

receivables<br />

3. collection of receivables<br />

4. protection against default in payment by debtors<br />

2009


FEW COUNTRIES HAVE<br />

RATIFIED THE CONVENTION<br />

STILL A USEFUL BENCHMARK<br />

FOR CONCEPTS<br />

2009


UK PRACTICE: MUCH BROADER<br />

• COMBINES ‘TRADITIONAL’ <strong>FACTORING</strong> WITH INVOICE<br />

DISCOUNTING<br />

• WILL SEE THIS IN THE <strong>FACTORING</strong> AGREEMENT TO<br />

COME<br />

2009


CONTRACTUAL AGREEMENTS<br />

Debtor has not<br />

agreed<br />

Imposed by law<br />

Payment<br />

redirected<br />

Pre-Payment Invoices<br />

Right to collect<br />

CREDIT<br />

RISK<br />

X<br />

Payment Goods<br />

2009


UK <strong>FACTORING</strong><br />

AGREEMENT<br />

RECOURSE<br />

OPTIONS<br />

NON-RECOURSE<br />

NO DISCOUNTING<br />

DISCOUNTING<br />

DISCOUNT AT MATURITY<br />

DISCOUNT TO COLLECTION<br />

AGENCY<br />

NO AGENCY<br />

NO DISCLOSURE<br />

DISCLOSURE<br />

2009


OPTION: If the Debtor defaults<br />

RECOURSE<br />

• Factor looks to Client<br />

• Sells back invoice; Client<br />

must pay<br />

• Client retains risk of Debtor’s<br />

default<br />

• Factor’s credit risk is on<br />

Client<br />

NON-RECOURSE<br />

• Factor accepts the risk of<br />

Debtor’s default for Eligible<br />

Debts<br />

• Provides Client with<br />

protection against bad debts<br />

• Factor has right to collect<br />

against Debtor<br />

• For Eligible Debts, Client has<br />

no risk<br />

Which option would the Client prefer?<br />

Which option would the Factor prefer?<br />

2009


RECOURSE <strong>FACTORING</strong> v INVOICE DISCOUNTING<br />

What’s the difference?<br />

2009


OPTION<br />

DISCOUNT AT MATURITY<br />

DISCOUNT TO COLLECTION<br />

• Discount rate charged against<br />

invoice amount from day<br />

Prepayment made until<br />

maturity date of invoice<br />

• This method prevalent in US<br />

• Advantage to Seller: Charge<br />

is fixed; no more charge if<br />

customer pays late<br />

• Disadvantage: No benefit to<br />

Seller if customer pays early<br />

• Discount rate accrues day-to-day<br />

(like an interest rate) on invoice<br />

amount from day Prepayment<br />

made until date of collection<br />

• This method prevalent in UK<br />

• Disadvantage to Seller: charge<br />

continues to accrue if customer<br />

pays late<br />

• Advantage to Seller: Less charge<br />

is customer pays early<br />

2009


OPTION<br />

NO DISCOUNTING<br />

DISCOUNTING<br />

• Client does not need<br />

financing<br />

• Prepayments made to finance<br />

client’s business<br />

2009


OPTION<br />

AGENCY<br />

• Client continues to manage as<br />

agent Sales Ledger and<br />

collections on behalf of Factor<br />

– Payment direct to Factor; or<br />

– Payment to Client as trustee<br />

• Advantage to Client: Minimal<br />

interference by Factor in Client’s<br />

business relationships (subject<br />

to Factor’s direction or ending of<br />

agency)<br />

• Client must have good<br />

administration; monitor DSO and<br />

receivables aging<br />

NO AGENCY<br />

• Factor takes over all<br />

responsibility for handling<br />

Sales Ledger and collections<br />

• Factor interjects itself into<br />

this aspect of business<br />

relationship<br />

• Advantage to Client: relief of<br />

administrative tasks<br />

• Advantage for Factor: greater<br />

control<br />

2009


OPTION<br />

NO DISCLOSURE<br />

DISCLOSURE<br />

• Presence of Factor not disclosed<br />

• No notification of factoring to<br />

customer<br />

• For clients who insist on not<br />

disturbing business relationship<br />

• Factoring disclosed by notice<br />

of assignment<br />

• Factor’s rights preserved—<br />

obtains ‘perfected interest’,<br />

I.e., can defend rights against<br />

3 rd party claimants<br />

• Disadvantage for Factor: could<br />

compromise ownership and<br />

security rights<br />

2009


Some fundamental points<br />

• Finances only post-invoice contractual obligations<br />

• Factor needs confidence that Debtor accepts goods<br />

• There needs to be absence of continuing obligations by the<br />

client after delivery of goods<br />

2009


BENEFITS TO THE TOURISM SECTOR<br />

• Possible cost savings<br />

• Potentially better financing<br />

terms<br />

• (extended payment providing<br />

approved by Factor)<br />

2009


COUNTRY BENEFITS<br />

• Import substitution<br />

• Foreign exchange reserves<br />

• Local economic development<br />

2009


USE & MISUSE <strong>OF</strong> <strong>FACTORING</strong><br />

USES<br />

• MISUSES<br />

• Short-term<br />

• MT equipment financing<br />

• Working capital financing<br />

• Grow sales & business<br />

• Manage receivables and<br />

credit<br />

• Proceeds for capital<br />

expenditures<br />

• Try to deal with existing bad<br />

debts<br />

• Last resort financing (seller in<br />

trouble, desperate for funds)<br />

2009


Beginning of modern factoring—USA 19 th C<br />

USA c. 1830<br />

• USA—rapid development of<br />

eastern seaboard<br />

• Imports from Britain & Europe<br />

– Sellers had no local<br />

knowledge<br />

– Did not know customers<br />

– Would have to keep<br />

inventories in foreign country<br />

• Mercantile agents<br />

– Took goods on consignment<br />

– Sold on behalf of principal<br />

– Some guaranteed payment to<br />

principal<br />

– ‘prescriptive right’ to<br />

reimburse against proceeds<br />

– Practice ahead of the law<br />

2009


2009


<strong>FACTORING</strong> USED TO BE CONSIDERED<br />

FINANCING <strong>OF</strong> LAST RESORT<br />

HAVING BANKS LINES A SIGN <strong>OF</strong><br />

BUSINESS VITALITY<br />

<strong>FACTORING</strong>: SIGNAL <strong>OF</strong> FINANCIAL<br />

TROUBLES?; HAVE TO HAND OVER<br />

ASSETS IN ORDER TO GET FINANCING<br />

2009


BENEFITS <strong>OF</strong> <strong>FACTORING</strong> HAVE LED TO<br />

GREATER USE AND ACCEPTANCE<br />

2009


1400000<br />

<strong>FACTORING</strong>: DOMESTIC v INT'L<br />

Source: FCI website<br />

1200000<br />

145,996 176,168<br />

103,690<br />

1000000<br />

86,486<br />

EUR MM<br />

800000<br />

600000<br />

400000<br />

68,265<br />

791,950<br />

930,061<br />

1,030,598<br />

International Factoring<br />

Aggregate Domestic<br />

1,153,131 1,148,943<br />

200000<br />

0<br />

2004 2005 2006 2007 2008<br />

2009


700,000<br />

DOMESTIC <strong>FACTORING</strong><br />

600,000<br />

500,000<br />

EUR MM<br />

400,000<br />

300,000<br />

Collections<br />

Non-Recourse Factoring<br />

Recourse Factoring<br />

Invoice Discounting<br />

200,000<br />

100,000<br />

0<br />

2004 2005 2006 2007 2008<br />

Source: FCI website<br />

2009


INTERNATONAL <strong>FACTORING</strong>: THE 2 FACTOR SYSTEM<br />

ADMIN<br />

FUNDING<br />

Laws<br />

Currencies<br />

COLLECTION<br />

BAD DEBT<br />

INVOICES<br />

IPREPAYMENT<br />

PAYMENT<br />

Local market<br />

knowledge<br />

Credit<br />

information<br />

Right to collect<br />

Payment<br />

redirected<br />

PAYMENT<br />

GOODS<br />

2009


www.agricap.com<br />

• Peruvian Packaged Asparagus<br />

Producer<br />

• Los Angeles, CA<br />

• ‘Financing for the Produce,<br />

Food and Agricultural<br />

Industries’<br />

• The situation: A 20 year-old Peruvian<br />

packaged food company, specializing<br />

in canned asparagus, needed<br />

additional working capital to<br />

adequately finance its day-to-day<br />

operations. A large portion of its sales<br />

were to very good foreign (U.S. and<br />

European) customers, however, its<br />

existing bank was not willing to<br />

provide financing on foreign<br />

receivables.<br />

• The solution: AgriCap provided an<br />

international factoring agreement for<br />

the client, which gave it the liquidity<br />

necessary to comfortably finance its<br />

operations.<br />

2009


REVERSE <strong>FACTORING</strong>: BIG BUYER LOOKING<br />

FOR BETTER TERMS<br />

Debtor has not<br />

agreed<br />

Pre-Payment Invoices<br />

Imposed by law<br />

Payment<br />

redirected<br />

Right to collect<br />

X<br />

Payment Goods<br />

RF programme Mexico: Nafin on-line factoring<br />

www.nafin.com<br />

2009


FARMER FINANCING IN THE CARIBBEAN<br />

• St. Lucia: Operative<br />

programme with Oxfam GB<br />

• Jamaica: Building a<br />

programme with Oxfam GB<br />

• Bsrbados: Barbados<br />

Agricultural Development &<br />

Marketing Corporation &<br />

Enterprise Growth Fund Ltd<br />

2009

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