technical
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FACTORING AND INVOICE
DISCOUNTING
RELEVANT TO CAT pApER 10
The areas discussed in this article are from study
sessions 28 (c), (d) and (e) of the Syllabus. In these
sessions, it states that students must be able to:
(c) describe how factoring works and the main
types of service provided by factors
(d) define invoice discounting and outline how this
form of factoring works
(e) calculate the cost of factoring arrangements
and invoice discounting.
Each of these syllabus requirements is discussed
in detail below.
STUDY SESSION (C)
DESCRIBE HOW FACTORING WORKS AND
THE MAIN TYPES OF SERVICE PROVIDED BY
FACTORS
Students seem to get thoroughly confused between
invoice discounting, factoring, and offering
discounts to customers. By giving a more detailed
explanation of factoring arrangements, I hope
that students will at least remember the basics
for the exam. In this section of the article, the
organisation providing the factoring is referred to
as ‘the factor’ and the company factoring its debts
is referred to as ‘the company’.
Factoring provides a form of advance against
a company’s trade receivables. Instead of the
company having to wait for cash from its credit
customers, the factor agrees to pay for a proportion
of the debts upfront. Typically, a factor will
pay up to 85% of approved invoices. Factors
may be independent organisations but are
often subsidiaries of major banks or financial
institutions. Whatever they are, one thing is for
sure. They will not want to pay out money that
they do not think they will get back. Hence,
they will want to closely examine the applicant
company, assessing the financial stability of the
company, its history, and, most importantly, the
quality of the company’s credit customers.
Students are often under the misapprehension
that factoring is a good way to recover monies
relating to debts that have been outstanding for
some time and are now proving difficult to recover.
This is definitely not the case. A factor will review
an applicant company’s sales ledger very carefully,
and if the factor thinks that any of the debts
are doubtful, it will exclude them from
its initial prepayment and from its list of
approved invoices for future advances.
Unlike invoice discounting, which is
discussed later, factors are involved in
the administration of the company’s sales
ledger. Their involvement includes:
When an invoice is raised
The company raises invoices itself in the
usual way and sends them to its customers. In
addition to this, however, each time an invoice is
raised, a copy is also sent to the factor. The factor
will then pay an agreed percentage of the invoice
value to the company. It will also take on the credit
control function. This will include issuing statements
to the company’s customers and telephoning them
if necessary.
When the customer pays the invoice
When a factoring agreement is in place, customers
must pay 100% of each invoice directly to the
factor. Each invoice must clearly show the factor’s
remittance details on it. Having received the
money, the factor will then deduct its fees, its
interest, and its advance from the remittance
before paying the balance to the company.
Unpaid invoices
If an invoice remains unpaid for a certain period,
Following recent exam sittings, it has become clear that candidates struggle with certain parts of the
CAT Paper 10 syllabus. This article explores some of these problem areas, with the aim of enhancing
students’ understanding, thereby improving performance in the future. This first article deals with
factoring and invoice discounting. A second article will discuss simple and compound interest rates
and the calculation of early settlement discounts offered to customers.
