Bookkeeping - Anyone use a factoring company?

You should post the invoices as normal in your books but set the factoring company up as a bank account. Every time the factors send you money the entries would be between this account and your actual bank account in TAS books. When the debtors pay the factor you should post the cash to the debtor ledger as normal but the other entry will be against the factored account and not your own bank account.

The factoring commission and interest will be debited to the factoring costs account and credited to the factoring account.

I won't respond to James general comments about factoring except to say that over 37,000 companies are now either factoring or invoice discounting with a combined turnover in excess of £118 billion so they can't all be wrong.

A total cost for factoring of 5% is quite high but it used to be traditional in many industries to offer a 5% discount for prompt payment and this is no different.

Ian

Just re-read Lyndas post, sorry you aren’t in the bookkeeping business at the moment. In non-service industries payment terms of 30 or 60 days or are the norm in many industries, I was thinking you where factoring your booking invoices not your partners business. Ian's solution will work equally well for the double entry although might be a bit complex for a small business. Ian - I am not knocking Factoring in all instances. It is a great thing for short term finance when a business hits a bad patch and there just isn’t any cash to meet immediate needs. It is however a poor value way to borrow in the long term and can disguise fundamental credit control issues that should be addressed in the first instance. I was involved in a company a few years back and factoring (stock, debtors the lot) was one of the factors that saved the company from going bust, but we sure as heck got rid of it as soon as the cash flow recovered. Looking at industry wide figures doesn’t really help identify the instances when Factoring is useful vs when it really is plain daft. I could say there where almost 2 million companies in the country with £XXXX billion turnover that don’t use factoring but that doesn’t really prove very much. Just like looking at these 5% discounts. What businesses actually do is ADD 5% to their basic invoice value and call it a discount if paid within 14 days. Most companies will pay on time as they borrow at far less than this. Its a basic credit control/marketing tactic. Factoring is very useful in appropriate circumstances, but those are not normally present in general trading conditions.
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James Smith
Chartered Accountant
www.jamesesmith.co.uk
01235 536 773

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Your indispensable guide to Small Business Bookkeeping, Self-Assessment & VAT

James - I wouldn't normally respond as your anti factoring stance wasn't germane to the question asked which related purely to bookkeeping but I am concerned that anyone coming here and searching on the term "factoring" would only read your post and assume that factoring is a bad idea.

I have been involved in the industry since the early days when many people thought as you do that factoring was borrowing of the last resort but times have changed drastically since then and the market place has changed with it.

Banks have never been interested in lending to the SME market and would only fund startups if well secured. Factoring has always been the first choice of funding for any business who were forecasting rapid growth as the traditional overdraft was geared to available security and not sales but in 2001 the Brumark ruling ( http://www.factoringsolutions.co.uk/factoring_brumark.htm) changed all that and what little interest the clearing banks had in lending to the SME sector quickly vanished and they started actively pushing as much of the lending as possible in this sector to their factoring subsidiaries.

An average factoring company client turning over £500,000 and a debt turn of 60 days would likely have £98,000 in outstanding debts. If this company approached a bank for an overdraft he would likely get 10% or 20% of this figure but a factor would be willing to inject just over £78,000 working capital into this company plus a sales ledger management service. The typical cost would be 1.5% of turnover plus interest on all funds advanced at 2.5% over Base Rate.

The total cost per annum in the above scenario would be in the region of £13,375 which if you wanted to relate it totally to cost of funds would be 17% with a free ledger management service thrown in. My preferred way of looking at a scenario like this is "How much extra profit could you make with a cash injection of £98,000 and more free time away from the burden of sales ledger management and credit control". If the answer is more than £13,000 the sums speak for themselves. If the answer is less than £13,000 then obviously it isn't a course worth pursuing.

Right at the moment I am dealing with a furniture manufacturer in Thailand who wishes to export furniture to the UK at a rate of about $4m per annum but doesn't want to set up a UK operation. Factoring will inject £365,000 into his business plus enable him to keep his UK overheads to a minimum.

Second is a chartered accountant working for one of the majors who has set up a contracting company to run in his spare time to contract hire out accountants. Anticipated turnover will be £1m in his first year. His customers will probably pay within 45 days on average but he needs to pay his contractors weekly meaning that he needs to find close on £100,000 to fund his business. No bank would be interested and whilst factoring may cost him a total of £20,000 it will enable him to generate an annual profit in excess of £80,000 from his sideline.

I am currently talking to an electrical contractor turning over £2m per annum and making small profits. He is quite likely to win contracts in the near future which will triple his turnover and generate highly significant profits but an extra £4m in sales means having to find huge extra resources to fund it. Factoring will not only inject £250,000 now but as the new contracts come on stream the funding will keep pace with sales which no other method of finance will do.

I was approached yesterday by a company selling accessories relating to the motor trade directly to the public via magazine adverts. Current turnover is £50,000 pa but he now wishes to sell to motor accessory retailers and is estimating that a network of sales agents could generate a turnover of at least £500,000 and possibly double that. He has to pay for the product within 14 days and the sales agents need to be paid fairly quickly, whilst the likely 250 plus cutomers are highly unlikely to pay within 60 days. I would be interested to know what other method of funding apart from factoring would be appropriate for this business bearing in mind that by factoring he will not only generate the necessary funding but also save one salary on a bookkeeper.

I believe that given the banks complete disinterest in lending to the SME sector factoring is now the first port of call to all appropriate companies resulting in a far more competitive market place all round

Ian

Ian we are talking about exactly the same things here - using factoring where no other sources of finance is available. I am not anti-factor, I am however pro using appropriate methods of financing for a given set of circumstances. For the micro business it is very unusual to use factoring unless you have exceptions circumstances such as the rapid growth in your examples.
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James Smith
Chartered Accountant
www.jamesesmith.co.uk
01235 536 773

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Your indispensable guide to Small Business Bookkeeping, Self-Assessment & VAT

An interesting debate!

We have two clients currently, who came to us from their banks' factoring division for some legal advice on the set up paperwork. They were being asked for debentures over the sales ledger which is common, but also as a start up, for personal guarantees from each of the shareholding directors. So hardly unsecured borrowing, as they also have an all monies charge for their existing overdraft secured on two of the directors homes in one company and the other has just one director with his home at risk.

Having seen so much of it with the smaller traders and Ltd co's with factoring agencies is Ian saying that some factors just secure on sales ledgers and require no other security? If this is the case I will happily refer the clients onwards as their current risk exposure could take them down.

Whilst some factors are willing to be more flexible on guarantees with established businesses most will want a personal guarantee or at the least some form of warranty to back up the facility with startups and fairly new companies.

In theory the director shouldn't be at risk in the event of the failure of the company unless unless more than 20% to 25% of the debtors don't pay and when this happens it is frequently down to client fraud which is what the factors like to secure against with their guarantee. Some factors will accept a much more limited warranty though instead of an unlimited personal guarantee.

There is insurance available to help minimize risks with personal guarantees and whilst this doesn't cover the full amount it can be useful in certain circumstances.

Ian