Which factor?

‘Growing, ambitious manufacturing company seeks extra funds toprovider to choose. finance sales expansion. Factors and invoice discounters welcome.’ If this is you, or one of your clients, how do you decide which service to pick and from which provider?

Factoring offers the double service of finance and sales ledger management.

The factoring company takes over the running of the sales ledger, freeing up the company’s management to run the business. With invoice discounting, the company retains control over the running of its sales ledger, simply having the option to draw down funds against its debtor balances.

Factoring costs more, since the company pays a finance charge on any sums advanced against debtors, plus a fee for the administration of its ledger. Invoice-discounting clients only pay the finance charge. But they still have to run their own sales ledger, with the associated staff and internal administration costs that brings.

Precise fee structures are negotiable, says Paul Hancock, senior vice president at Bank of America. Some companies prefer a higher interest rate and lower administration fees, for example. ‘We are prepared to be flexible,’ he says. ‘It’s a pretty competitive market at the moment.’

In choosing between services, the company has to decide whether it would benefit from the expertise of having a factoring company actually running its sales ledger – chasing up late payers and checking out new clients for credit-worthiness.

‘We now have one or two very big clients who effectively use us as a sales management service,’ says Peter Torrance, marketing director for Lombard NatWest Commercial Services. ‘They don’t use us for the finance – only for the administration management.’

The outsourcing factor

In a way, factoring is just another form of outsourcing, so companies that like the idea of specialising in core activities and handing out other functions to external specialists may be particularly drawn to it.

Torrance claims that where the factoring company does run the sales ledger there should be an improvement in debtors’ turnover.

And the faster the customers pay, the faster factoring clients receive the balance on any advances and the less chance those debts will go bad.

Exporters, in particular, benefit from the management aspect that comes with factoring. ‘Collecting debts in the UK is bad enough, but collecting in Italy or Spain, for example, is a nightmare,’ says Charles Anderson, managing director of BNY International.

International factoring companies can provide the network to pull in the debts more effectively. Supreme, an industrial textile distributor and exporter, has been using Griffin’s export factoring service since 1991. Supreme imports textiles from India and distributes them around Europe.

To help with slow payers, the #10m turnover business makes use of Griffin’s sales-linked finance (advances of up to 80% of invoice value), as well as its collections and credit management service. Supreme is typically owed between z1.5m and z2m at any time. ‘Freeing up the money owed to us helps finance our business,’ says managing director Sri Sriram.

‘But export factoring has also enabled us to keep our collection costs, banking costs and staff overheads to a minimum and yet operate the sort of credit control function that only major plcs could afford.’

Traditionally, size was a key determinant of which service a business took. Smaller businesses tended to have a factoring service, larger business invoice discounting. This was due to several reasons. Smaller companies simply had fewer resources to devote to debt management so potentially had more to gain from handing the job to an expert.

Secondly, smaller businesses generally had weaker controls, so factoring companies were less keen to simply advance them cash. They preferred to gain some comfort as to the quality of the debts by running the sales ledger themselves. ‘Factoring is more suited to smaller companies,’ says David Marsden, chairman of RDM Factors, a specialist in companies with a turnover typically less than #5m.

‘Invoice discounting is more suitable for more mature companies. It’s arms-length funding. To get comfortable about it you need to see a track record that the company can effectively collect its debts. There is often a migration. People start with factoring and migrate to invoice discounting.’ It can also go the other way. ‘Discounters reserve the right to transfer to a factoring facility if it doesn’t work out,’ Marsden warns.

Akrabend Associates is an example of a company that started using a confidential invoice discounting service from Griffin years ago, back in 1977, and is still going strong. Suppliers of hydraulic pipes to Massey Ferguson, and with a client list that includes names such as JCB and Baxi Heating, the company needs to deliver on time and be able to cope with sudden, large orders.

Now heading for a turnover of #2m, Brian Walton, managing director of Akrabend, believes the company could not have grown so fast without the Griffin service. ‘Our cashflow would never have matched our need for cash,’ he says. ‘I would have been constantly running to the bank for more money – and I would never have been able to borrow on overdraft the level of finance needed.’

Demographics relate to type

These days, the relationship between business size and service type remains, though it is weakening. Smaller companies are being granted invoice discounting, and larger companies are opting for a factoring service.

‘Today, companies with a turnover of around z1m can get invoice discounting,’ says Murray Chisholm, sales and marketing director for TSB Factors. ‘And there are companies with a turnover of #10-15m who use factoring.’

Chisholm links this development with the outsourcing phenomenon. ‘More and more companies are outsourcing all sorts of functions,’ he says. ‘The sales ledger is one that can be outsourced fairly easily.’

One other reason why smaller companies may be able to get invoice discounting these days is that there is so much competition for their business. ‘We have had to become more flexible,’ admits Ross Clarkson of Alex Lawrie.

‘We are doing more business on invoice discounting than we did in the past.’

The general rule used to be that companies with turnover of z1m or below had the factoring service, those with turnover of z1m or above could have either. ‘We reduced that to #500,000 for confidential invoice discounting,’ says Clarkson.

‘The reason was that we saw more businesses turning over #600,000 that were suitable. They had good systems in place. As the price of computer technology has come down, there are more and more PCs going into smaller businesses.’

Mark Hind, marketing director for Griffin Credit Services, says his company looks for clients with a turnover of more than z1m for its invoice discounting service. ‘But we look at how effective their credit management is,’ he adds. ‘If we can’t improve it, we will look at invoice discounting, if that is what they want.’

Technology is being used by the factoring companies too so that clients feel they have better control over their sales ledger, even if they don’t run it. ‘We have a system called ALDIS that gets over that feeling of loss of control,’ says Clarkson.

‘We have about 1,000 clients using it now. The system is a full management package. Companies can see what has happened to all their sales ledger accounts. They can see what the credit controller has done, who has been contacted.’

City Link Dundee uses the ALDIS service, having signed up for Alex Lawrie’s factoring service in 1993 when poor cashflow was holding the company back.

The franchise delivery company opted for a finance and credit management service that provides 75% of the value of unpaid sales invoices within 24 hours, the remaining 25% less service fee paid over when customers settle. As a result, Alex Lawrie is providing around #30,000 in working capital and City Link’s client base has more than tripled in the past three years.

Given that factoring carries less stigma than in the past, the confidentiality that can come with invoice discounting is less important a consideration for most companies choosing between services.

One company that does use confidential invoice discounting is Cambridgeshire-based Spearmark International, which makes houseware products such as Thomas the Tank Engine beakers and plates. The company is also producing World Cup 98 merchandise for high street retailers.

Spearmark approached International factors (now part of BNY International) in November 1996 because it was having difficulty financing the business during peak trading periods. ‘Since using International Factors, we have experienced our most successful year in terms of growth,’ says finance director Stuart Spink.

‘We experienced a 30% increase year on year, which has taken turnover from a steady z7-8m a year to its current level of #10m. A large part of this growth occurred during our peak trading period from October to November. Conventional banking facilities could not have enabled us to finance the money tied up in our sales ledger.’

Having decided on the service, the final question is, which provider?

Apart from the traditional factoring companies, there are the new entrants, such as Bank of America, which prefer to talk of their services under the heading ‘asset-based finance’. These lenders can offer a finance package that builds up security against debtors, stock, plant and machinery and even land and buildings.

The traditional factoring companies could do the same, but would need to co-ordinate with their fellow business units. ‘It will require people like ourselves to sharpen up our act to compete in putting these packages together, but it’s not adding anything new to the marketplace that couldn’t have been provided already,’ says Lombard NatWest’s Torrance.

At Griffin, Hind also says the group, headed by Midland, would look at proposals that involved providing funding against assets other than debtors.

‘If there is an appropriate proposal in front of us, we could do stock finance,’ says Hind. ‘But it’s not a core business for us. We don’t advertise the fact. We get plenty of business from our traditional service.’

Some clients may prefer to use a large provider, linked to a major bank, while others may prefer a service from a small independent.

RDM’s Marsden believes smaller providers, such as his, can fill a need for smaller companies in terms of personal service. Business start-ups in particular need lots of attention. ‘You can’t offer them a sausage machine service because they need lots of hand-holding,’ Marsden says. ‘The banks will put a template over every deal and say, “If it doesn’t comply with this, we are not interested.”‘

Independents offer flexibility

Marsden believes independents can offer more flexibility. ‘We have some clients we have hand-held through some scary moments and they have done well, he says. But the big players are also keen to sell themselves to small businesses.’

Eighteen months ago NatWest launched a service for companies with a turnover of between #50,000 and #300,000. ‘This was a new area of the market for us to get involved in,’ says Torrance.

The service, called KeyCash, is entirely run through PCs, with no paperwork. All data transfers are done by modem.

Chisholm believes potential clients should compare different suppliers thoroughly. ‘There are so many differences between the factoring companies,’ he says. ‘Clients have a much wider choice but they probably don’t research enough. They buy on rates and that’s their only consideration.’

Chisholm suggests comparing factoring companies on issues such as the typical debt turnover rate achieved, any restrictions on funds advanced, the ability to apply different payment policies to different customers and the minimum time taken to advance funds.

Under TSB’s same-day service, failure to deliver funds on time results in a #25 payment to the client. ‘We paid out 15 times last year on two million transactions,’ says Chisholm. ‘That means we were 99.99925% efficient.’

Businesses looking for extra finance now have a wide choice, not only in the service they receive, but also in identity of the provider. Continued competition looks set to keep the industry on its toes, which is good news for any business looking for extra finds now, and in the future.

Sarah Perrin is a freelance journalist.