Factoring debate Pt2 - Figure it out

Last week in Accountancy Age, Troels Henriksen, joint managing director of Kall Kwik, set out his views on why small businesses should avoid factoring.

While I respect his views, I feel his statements cannot go unchallenged.

I would suggest to Mr Henriksen that 22,000 organisations cannot have got it wrong. This is the recent figure issued by the Factoring & Discounting Association of the number of UK companies currently factoring, most of them totally successfully.

During 1997, factors handled #50bn of clients’ turnover – that’s a lot of cash.

The FDA also says that the number of companies using factoring and invoice discounting rose by 13% during 1997, and that FDA members collected their clients’ debts in an average of 60 days – significantly better than the national average.

In any industry, there are many high-quality service providers, as well as a few of those of lower standards. This may also be the case in factoring although, as an independent factor, I feel I can comment on behalf of many companies when I say there is a very strong ethos to be supportive of client companies.

In our organisation we go out of our way to provide what we call the ‘old-fashioned bank manager’ approach. To allege that ‘customer relationships do not matter’ to us is totally contrary to all logical thinking. Surely Mr Henriksen knows of the win/win policy under which everything possible is done to ensure a factoring company’s clients prosper.

The more successful they are, the more money factors make. Furthermore, by collecting cash efficiently, factors gain new clients from impressed debtors. Companies my own staff have chased for money have since become clients.

Mr Henriksen suggests that factoring is expensive. I would put to him the following scenario. A distribution company with a #1m turnover giving 45% gross margins and operating a typical overdraft of #50,000 to #80,000 (secured by a debenture) seeks additional funding to buy product to increase turnover 50%.

Assuming a 75-day debt collection period, that company will have, at any one time, outstanding debts of #200,000.

A factoring company will advance up to 80% of the value of those debts, in this case #160,000 – #80,000 more than its bank. And that is with no expansion in the debtors.

The company is therefore receiving, at a stroke, more than double the amount it was borrowing from the bank for the price of a service fee of 1% of turnover (#10,000), and interest charges of 2% to 3% above base rate on the advance itself (in line with the best offer from most banks). And remember, this includes a credit management service, sales ledger service, and collections with optional credit cover to protect against bad debts.

Therefore, an outlay of #17,200 brings in funds and services to generate an additional #500,000 turnover at 45% gross margin. That’s #225,000 additional gross profit. Add to this the opportunity to obtain supplier discounts for quicker payment and reduction in senior management time in chasing money when the cash flow dries up.

Factoring can therefore be self-financing, with the added benefit of providing not only cashflow, but also funding which will enable the business to grow significantly – much faster than would otherwise have been the case.

Mr Henriksen is harsh in his criticism of the manner in which companies undertaking factoring use the funds we advance, implying that they are unable to properly manage the cash. Nothing could be further from the truth.

And as for small companies never getting out of factoring: a vast number of organisations have profited from enhanced cashflow and the provision of working capital – to the extent that they are able to operate their companies with a substantial credit balance, and no longer have need of factors.

Some businesses have grown so well that they have become an attractive acquisition for a larger organisation – once again taking them out of the factoring scene.

I am surprised to hear an allegation of the withdrawal of a factoring facility ‘at the drop of a hat’, for it is the norm for companies undertaking factoring to agree to stipulated periods of contract of three months, six months, one year. The only time a factor is likely to terminate a contract is for a serious breach such as the issue of false invoices or persistent banking of factors’ money. This is in stark contrast to some banks who can pull the rug from under a company’s feet due to an overdraft which is repayable on demand.

Most factoring companies do not insist on personal guarantees. Factors normally ask company directors to guarantee that invoices are bona fide.

I am sure it will be accepted that this is not unreasonable, for all we are asking is an assurance that the debt is collectable.

There are situations where the nature of the business is not suitable for factoring and, yes, if there is not a good relationship between factor and client, there can be problems. But the relationship is key to a factoring deal. Independent factors, in particular, are striving to maintain the partnership element of business.

Mr Henriksen’s advice to his Kall Kwik franchisees may be ‘don’t factor’, but he may be interested to know that at least two of them are factoring extremely successfully with my own company. I would say to any small business, not just a franchised organisation, but any business wishing to expand and secure an adequate cash flow, to consider factoring. It works, it works well, and it will go on working for the benefit of UK industry and commerce.

Leslie Bland is managing director of Close Invoice Finance