Manage Factoring and Invoice Discounting Agreements - Assignment Example

 Manage Factoring and Invoice Discounting Agreements. Question 1 When company makes sales to their clients some clients are unable to pay for the purchases promptly.1 The company may not necessarily have to wait until the time when the debtor will settle the invoice in order to get money to continue with its operations. The seller may raise an invoice and set the date when they expect the debtor to settle the debt. The seller may raise money against the invoice by presenting the invoice to an invoice factoring or discounting agent who pays some proportion of the amount to the company and wait to receive the amount after the end of the credit period. Invoice factoring and discounting are processes through which a company can get quick cash by assigning the debt to another party who could be a person, a commercial bank or other financial institutions.2 Depending on the nature of contract between the company and the financing agent the duty of collecting the debt form the client is either assigned to the agent or remains under the company. The company will have to identify a reliable factor or invoice discounter to get cash against the invoice and then use the money to advance its operations.3 In order for the company to identify appropriate factoring or discounting agent, they should consider the agent whose term are favorable in terms of low fees, issue maximum deposit, low interest charges and be able to pay the amount within the shortest time possible.4 The decision by the company as whether to discount or factor the invoice will depend on the value of the invoice and the stability of the company. If the company’s turnover is below $250,000 per annum and the company does not have in-house credit control systems the agents will prefer factoring the invoice.5 However, for companies with an annual turnover of more than $250,000 and adequate6 internal credit control systems discounting is essential because of the high cost involved. When factoring the invoice the agent usually charges high fees and interest rates. Discounting of the invoice does not alter the arrangement between the trader and the debtor because the responsibility of collecting the debt rests with the trader, and the debtor is not aware of the arrangements.7 The company should discount its invoice in order to ensure its relationship with debtors remains unchanged. In fact, the clients may lose trust on the company in case the trader opts to assign debt to a factoring agent. The low charges of made by invoice discounter makes it better than factoring, even though the risk of bad debt is taken up by the trader.8 However, if the company is not very stable financially factoring the invoice is the best option because they do not suffer loss in case the debtor fails to settle the invoice amount. The invoice is the evidence required to ascertain that a company has a debtor. Whenever a company makes credit sales they raise an invoice and the debtor sign it to acknowledge that they owe the company the amount stated in the invoice.9 However, before the company sells goods on credit they should establish the credit worthiness of the buyer. The procedure of establishing credit worthiness involves investigating the buyer’s previous credit records, the period the buyer has been in business, business profitability and the collateral issued as security against the debt. The collateral required by the company before advancing credit should have greater value than the amount of debt being advanced and should be something tangible.10 For example, logbook, title deeds and financial assets such as bonds and stocks are appropriate collateral securities against which a borrower can obtain debt from a company. Before a factor accepts the invoice from the company, they have to make some assessment of the company making application, company’s financial stability and the credit worthiness of the company’s debtors.11 Usually the company pays up to eighty five percent of the total invoice value to the applicant company. After the factor is contented with the financial stability of both the applicant company and the company’s debtor, the factor will give the agreed amount to the company and wait until the maturity of invoice to collect the total amount from the customer.12 The factor sends a statement to the customer to inform the customer of the transactions that have taken place between the factor and the applicant company. When the factor collects the entire amount owned by the customer to the applicant company, they make appropriate deductions including the amount they paid to the company and its fees for their services and interest, and then remit the balance to the company.13 If the customer cannot clear the debt the position between the company and the factor depends on whether the agreement was with or without recourse. If the agreement involved recourse, the factor will get the money they advanced to the company while an agreement without recourse will limit the factor from recovering the money advanced to the company. The company should evaluate the cost of hiring a credit controller and compare it with the cost it would incur to assign the debt to a factor or invoice discount.14 To calculate the purchase price and the fees appropriate when assigning the debt to a third party, the company should consider the debtors turnover. The company should obtain the product of the sales price and debtor’s turnover to get the account receivables or debtors that require financing. The charges off discounting are obtained from the debtors and it includes charges on the amount advanced to the company, charges on the balance that has to be settled after the debtor has cleared the outstanding balance and the administration charges.15 For example, if the credit sales were $200,000 and the factor was willing to give an advance of 85% and the fee charges are 10%, administration fee of 2% and overdraft charges of 8% the total charges will be as follows; charges on advance = 85% of 200,000 * 10% = $17,000. Overdraft = 15% of 200,000 * 8% = $2,400. Finally, the administration fee; 1.3% of 200,000 = $2,600, hence making the total cost of factoring $200,000 to $22,000. The company will be able to get the balance which $178,000 from the original debt of 200,000. If the company decide to raise money by discounting the invoice it will have to inform the debtor of the new arrangement between the factor, the client and the factor.16 The client will be notified of the total amount required from them according to the invoice in order to confirm to the factor that the value indicated in the invoice is the amount the factor will require from the agent. Such an arrangement is essential because it alleviates the possibility of fraud by either of the parties. The debtor will be given all the details of the factor including the account number because the debtor will submit the money to the factor on behalf of the creditor.17 There is a significant risk for both company and the debtor in case the client fails to pay because the company will incur additional charges paid to the factor irrespective of whether the debtor pays or fails to pay the amount. The factor suffers risk in the arrangement because in case of bad debt and the company goes bankrupt the company may not be able to recover the amount advanced to the company.18 The company, the factor and the debtor may constantly exchange the documents of all transactions in order to ensure the new arrangement is progressing as planned. Question 2 This business will benefit from invoice factoring because the debtors value is not huge enough to secure discounting facilities. Also, the company is very well established hence by factoring they will be able to transfer the risk of bad debt to factor without risking going bankrupt. With the additional capital they raise from factoring the company will be able to install credit controller in order to increase the debtor’s turnover. XYZ company deficiency with relation to debt evidence because they do not have any approval for the supplies to their debtors and this may limit the company from obtaining a credible factor for the debts. Since the main debtor has a slim chance of settling the debt the company should limit the debt to a 5% of the sales ledger because this amount will be equal to the value of assets in excess of the liabilities. The CFI should offer a purchase price of $144,000 since the company has already issued a credit not worth 10% of their sales. The factor should request for the invoice, credit notes and collateral against which the debt were issued before factoring the invoice.19 The appropriate steps to follow when determining the debtor ledger is assess the invoice, date of the sales, debtors’ turnover, collateral documents, and credit notes to establish the actual outstanding amount, the repayment period and the value security of the debt.20 The client can draw 80% of the $189,995 less 1% of $189,995 = 159,996-1900 = $158,096. Before the factor accepts to take ownership of the debt, they should consider the ability of the debtor to pay the money owing to the client. However, if the debtor is not registered for the business they are conducting that the debtor may not be valid hence increases the risk of bad debt.21 In this case of XYZ I cannot approve the invoice for funding because there is a high possibility that most of the debts may not be paid. In addition, there are many debtors while the amount of debt is so low hence the cost of factoring it will be quite high. In case the company decides to factor the invoice they should inform the debtors of the new arrangements by sending those invoices, details of the factoring agent and the account in which they will deposit the amount owning the client.22 However, the debtor should be informed that the terms of the agreement between the factor and the client will not affect the terms set between the debtor and the trader. Bibliography Blayney, Mark (2007). The Factoring and Invoice Discounting: A Creative Business Finance Guide. Bad-Press.Companyuk, pp.12-34 Bullivant, Glen (2012). Credit Management. Gower Publishing, Ltd., pp. 635-703 Correia, Carlos., David, Flynn., Uliana, Enrico. & Wormald, Michael. (2012). Financial Management. Juta and Company Ltd, pp. 12-23 Edwards, Burt. (2004). Credit Management Handbook. Gower Publishing, Ltd., pp. 451-513 Mäntysaari, Petri. (2009). The Law of Corporate Finance. Volume III: Funding, Exit, Takeovers. Springer, pp.52-112 Read More