69 SUMMARY HISTORY The first Credit Factors in modern times were textile agents in the United States of America. In 1 890, a tariff on imported textiles of just under 50% had the effect of reducing the traditional business of the textile agents on the Eastern Sea-board of the USA to levels which made many of them drop their traditional business of importing, storing and selling textiles. In particular Oelbermann, Dommerick and Co led the way by continuing to act as agents for American suppliers, effectively providing a credit factoring service to them without selling. Most of the Factors2 customers were retail stores, or clothing manufacturers who bought cloth for making up. Their clients were the textile mills and converters who operated in the USA and had their own sales teams. The agents merely took up where the originators of the sales left off. This was remarkably similar to present-day credit factoring. They tended not to move into other industries, preferring to stay with the business which they understood best. In the 1 890s, also, the banks in the United States explored the possibilities of invoice discounting, the branch of factoring which is fastest growing in the UK in the 1980s. The banks lent against the security of commercial accounts receivable, on a resourse basis (that is, the client, not the bank, bore any bad debts). The fact of the bank's involvement was not transmitted to the customer so that this was the start, in modern times, of confidential invoice discounting. According to Biscoe, in his book Credit Factoring ( Butterworths,1975) the first receivable financing company not connected with a bank was established in 1904. This company not only notified the customers that they had rights over the debt but also demanded recourse to the supplier.Not suprisingly, clients objected to their customers being informed and the receivable financing company dropped notification to customers on receipt of independent verification of the accounts submitted(audit). Because the risk was greater in this type of unnotified receivable financing, the companies concerned had to take strict precautions against themselves being defrauded by their clients. The risk that customers would not pay was a secondary one. They required duplicate invoices to be supplied and detailed information about the customers who had paid their acconuts to the client. Itwas at this time that many present-day procedures were pioneered. They established norms about the percentage of receivables which they would finance at between 70% and 80% -still the norm today. They established detailed accounting procedures for communication of invoices raised and sums received - still the norm today. They established criteria about the industries and the types of customer for which they would be willing to supply finance. These were not quite70 the same as today, when credit assessment procedures are so much more sophisticated, but still serve as a guide. It was at this time that the accounts receivable financiers became involved with companies which needed 'last resort1 funds-not an area that the factoring companies today would favour. However at that time, many factoring clients had reached the and of their bank credit and had exhausted whatever capital they had. This type of financing was, therefore, of particular value, but it had two main drawbacks. It was expensive and it could be restrictive. Because factoring had started in particular industries, the factoring companies and accounts receivable finance companies developed detailed knowledge both about the industry and about the businesses within that industry. If a factoring company acted for several suppliers to the same customer then they had a very good picture of the customer's position could judge when the time was right to expand or restrict further credit. That is one of the greatest advantages in factoring debts today. In summary, therefore, many facets of factoring today relate back nto that period just before the turn of the century when, by a quirk of fate caused by a new philosophy about textile imports, the factoring industry as we know it was born. Economic Value Of Factoring The value of factoring to the economy has undoubtedly been seriously under estimated and there is a need for empirical research in this area. There are no barriers to entry into the industry but there is a need for expert staff. Fnds are of course an essential pre-requisite to entering the business, but if the expertise were there funds would probably be found. One of the questions of greatest interest is whether factoring can make a positive contribution to the economic growth of the country. Do businesses prosper because of factoring? The prima facie evidence suggests that they do. Factoring has played a major role in the expansion of many medium sized companies, and it is being used increasingly in start-up situations. Could this hep be extended to very large and very small companies? Our view is that there is considerable scope and that independent research to support factoring is, or should be, a major priority for the ABF( Association of British Factors, the trade association representing factoring companies in the U.K.). This research could cover such areas as whether new companies should be encouraged to enter the field, whether existing companies are collectively as efficient as they might be, and whether the government should assist in any way to ensure that the maximum potential of factoring is realised.71 Summary of the Basic Factoring Facilities AGENCY FACTORING. This facility provides both finace and protection against bad debts. The supplier continues to collect cash from his customers as the agent of the Factor, who has purchased the debts. The supplier retains control over the debtors' ledger.The Factor provides credit limits and guarantees- to pay if any approved debtor is unable to do so. The Factor will then rank as a creditor in any subsequent action against that debtor. Agency factoring, is not normally available on export sales but can be provided to a supplier in respect of UK sales as an adjunct to a full factoring service on export sales. The most suitable cases for agency factoring are where there are many small invoices to many small customers. As explained the way that a Factor bases his charger on average invoice values, inter alia, makes full factoring expensive for this type of operation. Agency factoring may well fit the supplier's needs and will obviosly be considerably cheaper, varying from about 0.5% to 1.2% of factored sales, plus discounting charges at rates similar to those on an overdraft. CONFIDENTIAL INVOICE DISCOUNTING. This facility provides cash against selected invoices or against a whole ledger. The debtor is unaware that the Factor is involved. Well-established companies seeking finance for expansion are the most suitable for this facility. No credit protection is provided, so that in the event of a bad debt the supplier has to meet it himself. FULL DOMESTIC FACTORING.This is the full facility which involves the accounting for the debtors 'ledger to be transferred to the Factor who accepts the risk of bad debts. The Factor provides the supplier with detailed management information and carries out all follow-up procedures. Provided that the amounts invoiced are within the limits agreed by the Factor, full credit protection is included. Up to 80% of invoice value can be drawn immediately or at some specified point. The cost of this facility is calculated in two segments. Firstly, the amount advanced against invoices before payment of the invoices is received by the Factor is charged for at a rate above bank base rate, like interest but expressed as a discounting charge. Secondly, the Factor calculates a service charge based on the amount of work likely to be undertaken-somewhere between 0.5% and 2.5% of factored sales. The exact figure depends on the account turnover and the amount of credit risk assessed. EXPORT FACTORING.Export factoring is fundamentally the same as full domestic factoring, whereby immediate cash is available to the exporter and the Factor manages the sales ledger and carries out all follow-ap procedures, insuring the risk of non-payment. The cash is usually available either in sterling or in the currency of invoice at the option of the exporter. The charges levied by the Factor are broadly similar to those in domestic factoring, approximately 0.75% to 2.5%'72 of export debts factored. Considering that this covers the exchange risk on amounts owed, these charges seem very reasonable in comparison to domestic factoring, but this is partly because the Factor is able to cover some of the risk in one of two main ways. RECOURSE FACTORING.The second most common type of factoring. This provides finance up to 80% of invoices submitted, and the Factor administers the debtors 'ledger, carrying out all follow-up procedures. What it does not provide is bad debt cover. If the debtor does not pay within an agreed period, perhaps 90 days, the supplier has the amount debited back to him and he has to do his own chasing (although, for an extra fee, most Factors will chase the debtor through the courts). SUMMARY OF ADVANTAGES AND DISADVANTAGES Full Domestic Factoring Advantages: Provides a full ledger accounting service Provides automotic guidance on credit limits Provides advice on all aspects of credit management Provides finance (up to around 80% of amounts invoiced) flexibly Provides credit insurance Customers tend to pay a Factor more quickly Provides better management information Disadvantages: Customers may not like paying a Factor Less control by the client over the day-to-day running of the sales ledger Shared responsibility for credit limits Shared responsibility for collections procedures and policies Confidential Invoice Discounting Advantages: Provides finance up to agreed limits related to invoiced sums Provides credit insurance (usually) Provides advice on most aspects of credit management Provides guidance on credit limits Disadvantages: Customers cheques have to be paid over the Factor Suppliers still have to chase their own debts Recourse Factoring Advantages: Provides guidance on credit lines Provides finance Provides advice73 Provides a full ledger service Disadvantages: Supplier bears risk of non-payment by customer Customers may not like paying a Factor Less control by the client over the running of the ledger Shared responsibility for credit policy, limits etc Exports and other International Factoring Advantages: Credit insurance Finance Ability to tap into local knowledge about conditions overseas Advice and guiadance on exporting procedures Advice and guiadance on payment procedures Advice and guiadance about credit limits Advice and guiadance about credit policy(e.g. terms of credit) Disadvantages: None The factoring industry has a very rosy future if only a few of our expectations come to fruition. We expect greater support for the Factors from their parent banks and greater demand for factoring as a means of financing. It makes a great deal of sense for certain types of business, mainly those selling to other businesses, to move to factoring their book debts and in the absence of attraction to other types of asset-based finance such as leasing, the growth of factoring in the next few years will be spectacular. We expect the industry to be the subject of more research and we recommend that the industry itself should sponsor that research so that the researchers will have ready access to appropriate information about the industry and can speak freely with the leading figures. The industry can and should take the lead in getting some changes in the law relating to factoring, particularly in the field of assignment of Crown debt, and there is no reason why it should not spearhead changes in accounting standards to ensure that an appropriate standard is developed for factoring. In the future there will be a need to sell the service more overtly than hitherto which will involve larger sales forces and, we believe, greater use of modern advertising techniques such as television and local radio. The last review of the law relating to factoring was undertaken at the time of the Judicature Acts of 1873 and we suggest that there is a strong case for another review.74 We view with some foreboding the recent intervention of Unidroit, an international body of lawyers who are intent on unifying the private law in each of the European contries. That body has much influence on the EEC, who do not seem to recognise that the Unidroit approach is essentialy an academic one, which may not be best suited to dealing with the practical problems which face European businessmen in today's economic climate. Their interest in factoring should be countered by the strongest possible representation of the UK's interests on the Unidroit technical committee responsible. Finaly, we regard the expansion of factoring as inevitable, which is fundamentally a good thing for the british economy and for the factoring industry, of course, and we believe the Government should do everything possible to encourage that growth. It is likely that there will be growth in the confidential invoice discounting business and the Factors who provide the full factoring service, without recourse, should step up their compaign to alert potential clients to the pitfalls of opting for the finance rather than the full service. It seems inevitable, also, that the success of the factoringindustry will undoubtedly attract unwelcome attention from `in and out` bankers who see the way clear for making a killing on the financial aspects of the transaction without providing a proper service. We hope that this book will show them that although the factoring industry may seem to be ripe for a quick `in and out` operation while the going is good, the existing companies have a very good reputation and public acceptance of factoring has been largely due to the very professional approach of these companies.
