by Gen Merritt, Vice President, Portfolio & Risk Management
If you attended the April 2010 IFA Annual Factoring Conference in Scottsdale, AZ, you may have dropped in on Factoring Jeopardy, where you were sure to see that certain categories did not fare so well for those participating in the game. For me, that category was of all things: History.
Yes, factoring does go back over 4,000 years to the Mesopotamian King Hammurabi. He was the ruler who established the world’s first metropolis, Babylon, considered the bed of civilization. The Mesopotamians are credited with being the first to implement notes/borrowings on clay tablets between two parties. These clay ‘contracts’ indicated promises to pay; they were promises for future payments. This concept expanded trade and increased economic power for that time, setting a foundation for certain alternative forms of financing today.
Since then, factoring has evolved, becoming a critical financial tool for doing business in almost every civilization that followed, the Romans included, who were the first to sell discounted promissory notes. The first documented form of factoring in the American colonies, however, was prior to the revolution.
Merchant bankers in Europe gave the American colonists advances for materials, allowing the colonists to harvest their lands. Raw materials like cotton, furs, tobacco and timber were shipped from the colonies to Europe. Factors during these colonial times advanced against the accounts receivable of these companies. This practice became very beneficial to the colonists, as they didn’t have to wait for the money to begin their harvesting again.
Later, during the economic revolution, factoring became more concentrated on the issue of credit, as factors began assuring payment for certain clients (today known more as non-recourse factoring). Before expanding to varied business types after the war, factoring specifically catered to the textile and garment industries in the United States.
By the 1960’s and 1970’s, an escalation of interest rates and tighter credit spawned a new interest in the factoring market, with a number of private factoring companies coming into existence. By the 1980’s, further rate increases combined with new regulations within the banking industry caused many small businesses to seek alternative sources of funding outside of traditional banking. It was at this time that factoring became a more popular option for many of these companies.
As many of you know, factors make funds available even where banks cannot often do so; typically, factoring companies focus on the creditworthiness of the customer (debtor). In contrast, the fundamental emphasis in a bank lending relationship is on the creditworthiness of the company itself, not that of its customers.
Factoring is a financial transaction whereby a company sells its invoices/accounts receivable to a factor at a discount. In exchange for this, the company receives immediate working capital. Three parties are involved in the transaction: the factor, the company seeking financing and their customer (the account debtor). The sale of the accounts receivable transfers ownership of those invoices to the factor, at which time the factor obtains the right to receive the payments made by the customers.
Today’s factoring still focuses on advancing funds to small to mid-size, rapidly growing companies who sell to larger, creditworthy customers. Factoring is among one of the most effective and efficient forms of financing utilized by businesses. It immediately improves the cash flow of a business.
In addition, today’s factor offers other support services for their clients including providing credit checks on new and existing customers, sending monthly statements to customers for payment, performing collection calls, processing and maintaining history on invoices and customer payments, and providing reporting for this information, typically with online access for the client. Some factors even provide additional financing services for their client companies.
To learn more about factoring in general and specifically about our factoring process and unique funding solutions at Allied Affiliated Funding, please contact us at 1-877-404-9904.
