Tag Archives | creditworthiness

History of Factoring

History of Factoring

Factoring is a word often incorrectly used synonymously with accounts receivable financing. In Europe, the term “factoring” has become the term for accounts receivable financing in general; but in the U.S., this term refers to a specialized form of financing that involves the actual transfer of the ownership of the receivable to the lender, more accurately known as American Factoring. Factoring is a financial transaction whereby a business sells its accounts receivable (i.e., invoices) at a discount. Factoring differs from a bank loan in three main ways. First, the emphasis is on the value of the receivables, not the firm’s creditworthiness. Second, factoring is not a loan but the purchase of an asset (the receivable). Third, a bank loan involves two parties, while factoring involves three.

Parties Involved in Factoring

The three parties involved in a factoring arrangement are the seller, the debtor, and the factor.

The debtor owes the seller money, usually from the purchase of goods or services. It is common in business-to-business transactions for a seller to offer terms that allow payment for goods or services at some time after the actual delivery and acceptance of the goods or services.

Once the client (the debtor) has accepted the goods or services, the resulting obligation to pay the seller (usually represented as an invoice) becomes a negotiable instrument that can be sold.

In factoring, the third party in this transaction, the factor, buys the invoice(s) from the seller, usually at a discount to allow for the factor’s return and with a reserve, which is a margin the factor holds back until the receivable is retired by the debtor. Upon receiving payment on the invoice at its full face value, the factor remits the reserve to the seller.

Misconceptions of Factoring

There are many misconceptions about factoring, although it is an extremely old form of financing. It was first used in the U.S. in the textile industry, which was an industry of small, rapidly growing businesses selling to large retail chains and clothing manufacturers. It was also a common form of financing commerce in England, and some rules for factoring are even found in the Code of Hammurabi, the first set of laws governing commerce in ancient Babylonia.

For more tips on how to improve cash flow, click here to access our 25 Ways to Improve Cash Flow whitepaper.

history of factoring
Strategic CFO Lab Member Extra

Access your Strategic Pricing Model Execution Plan in SCFO Lab. The step-by-step plan to set your prices to maximize profits.

Click here to access your Execution Plan. Not a Lab Member?

Click here to learn more about SCFO Labs

history of factoring

See Also:
Another Way To Look At Factoring
Accounting for Factored Receivables
Can Factoring Be Better Than a Bank Loan?
Factoring is Not for My Company
Journal Entries For Factoring Receivables
How Factoring Can Make or Save Money
What is Factoring Receivables
The What, When, and Where about Factoring
History of Accounting

0

Credit Rating Agencies

See Also:
5 Cs of Credit
What are the 7 Cs of banking
Line of Credit
How Important is Personal Credit in Negotiating a Commercial Loan?
Improve Your Credit Score

Credit Rating Agencies

Credit rating agencies rate bonds based on the creditworthiness of the bond issuer. Agencies publish letter grades for bonds to indicate the quality of the security and the ability of the issuer to repay the debt. In other words, a credit rating agency determines the degree to which a bond issuer will be able to repay their debt. Well-known credit rating agencies include Fitch, Moody’s, and Standard and Poor’s.

Credit Ratings Definitions

Credit rating agencies rate bonds as investment grade corporate bond (high quality) or non-investment grade (low quality; junk bond) based on the creditworthiness of the issuer. A bond is given a grade, and the grades are typically ranked like this: AAA, AA, A, BBB, BB, B, CCC, CC, C, and at the bottom is D.

The highest quality corporate bonds will have a rating of AAA. (US government bonds are considered risk-free and are ranked above AAA.) The lowest quality corporate bonds are rated D, or already in default. Anything rated BBB or above is investment grade. Anything rated BB or below is non-investment grade corporate bond. Different bond rating firms may use different variations of the above rating system. For example, a rating agency may include plus (AA+) and minus (BBB-) signs to add levels to the bond rating system.

Lower quality bonds return higher yields than high-quality bonds. The higher yield compensates the investor for the greater risk of default associated with the lower quality investment.

Bond Rating Systems

Here are some examples of bond rating systems:

Fitch’s Rating System:

Investment grade corporate bond:

AAA, AA+, AA, AA-, A+, A, A-, BBB+, BBB, BBB-

Noninvestment grade corporate bond:

BB+, BB, BB-, B+, B, B-, CCC+, CCC, CC-, CC, C, D, NR

Moody’s Rating System:

Investment grade corporate bond:

Aaa, Aa1, Aa2, Aa3, A1, A2, A3, Baa1, Baa2, Baa3

Noninvestment grade corporate bond:

Ba1, Ba2, Ba3, B1, B2, B3, Caa1, Caa2, Caa3, Ca, C

For details regarding Standard and Poor’s credit rating system:

standardandpoors.com

credit rating agencies

0

Asset-Based Lending

If your company is in need of financing but it has been a challenge obtaining it from a traditional lender such as a bank, then you might consider alternative lending sources, such as asset-based lenders. Asset-based lending or ABLs will lend against collateral. Comparatively, other types of lenders lend based on your creditworthiness. As a result, this is what tends to make it difficult for start-ups and those with recent losses and cash flow difficulties from obtaining a bank loan.

Asset-Based Lending

I came across an interesting article in the Journal last week which detailed the benefits of asset-based lending, especially if it is difficult for you to quality for a bank loan.

Here’s a great article comparing traditional commercial bank financing to asset-based financing.

If you want more tips on how to improve cash flow, then click here to access our 25 Ways to Improve Cash Flow whitepaper.

Asset-Based Lending
Strategic CFO Lab Member Extra

Access your Strategic Pricing Model Execution Plan in SCFO Lab. The step-by-step plan to set your prices to maximize profits.

Click here to access your Execution Plan. Not a Lab Member?

Click here to learn more about SCFO Labs

Asset-Based Lending

0

LEARN THE ART OF THE CFO