Page 373 - F1 Integrated Workbook STUDENT 2018

Short term finance and investments

1.2 Factoring

This is outsourcing of the credit control department to a third party. The debts of the
entity are effectively sold to a factor (normally owned by bank). The factor takes on
the responsibility to collect the debt for a fee. The factor offers three services:

 Debt collection – The credit control function.

 Financing – Funds may be advanced to the company prior to the debt being
collected.

 Credit insurance – The factor may take the responsibility for irrecoverable
debt. For this to be the case the factor would dictate to whom the entity was
able to offer credit. This is called ‘without recourse’ factoring.

The factor is often more successful at enforcing credit terms, leading to a lower level
of debts outstanding. Factoring is therefore not only a source of short-term finance
but also an external means of controlling or reducing the level of receivables.

1.3 Invoice discounting

This is a service also provided by a factoring entity. Selected invoices are used as
security against which the entity may borrow funds. This is a temporary source of
finance, repayable when the debt is cleared. The key advantage of invoice
discounting is that it is a confidential service and the customer need not know about
it.

One use for invoice discounting is as a key financing tool for new businesses such as
management buyouts (MBOs). The creditworthiness of their customers is probably
higher than their own and is utilised to borrow funds.

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