Debt Recovery Part 1

Debt recovery has always been a problem for businesses; in some cases, the debt represents a substantial proportion of their profits, tantalisingly out of reach unless they marshal legal and financial resources to obtain what is rightfully theirs.

The expense and time involved in legal methods for debt recovery mean that it is always advisable to attempt to reach an agreement with the other party. Indeed, a court will expect that the parties have acted reasonably in exchanging information to facilitate settlement before commencing proceedings.

Any agreement to change the time for payment, or to accept payment by instalments (a payment plan), should be recorded in writing and it should be clear what the consequences will be if the other party fails to adhere to the payment plan. Any agreement to accept less than the amount due must be carefully drafted to ensure that it is legally binding.

Financing

Factoring and Invoice Discounting

These are ways to raise short-term finance. It involves a company selling its book debts (and other receivables) due from its customers at a discount to a finance company for an immediate cash payment.

Both require specialist agreements and there are advantages and disadvantages which need to be considered.

Factoring

Factoring involves a legal assignment of the debt. A legal assignment must be in writing and notice of the assignment must be received by the customer.

Generally, a typical factoring process will involve a company supplying goods or services in the course of business and then sending an invoice and a notice of assignment to the customer. The company will then send a copy invoice to the factor who advances funds (equal to an agreed percentage of the gross invoice value) and will collect the debt and administer the sales ledger. Depending on the arrangement, the factor may or may not bear the risk that the customer will not pay.

The advantages of this method can be:

• A quick way to raise cash.

• Suitable for small companies as it is a means of outsourcing debt collection.

• Viable alternative to raising cash from other financial institutions.

• If it is agreed, the risk of non-payment is passed to the factor (in this type of factoring, the amount of the advance payment is usually less).

The disadvantages can be:

• If it is agreed that the factor will take on the risk of non-payment, the funds generated are usually lower.

• If it is agreed that the factor will not take on the risk of non-payment, the company retains the risk.

• Factors usually use tougher collection procedures than the company, which might harm the relationship with the customer.

• The fact that the company factors its debts is disclosed to the customer, who may stop dealing with them as a result.

Invoice Discounting

Invoice discounting involves an equitable assignment of the debt. If the criteria for a legal assignment are not met, then it is an equitable assignment.

This is more suitable if the company has established credit control procedures because, unlike factoring, they will retain the responsibility for collecting the debts and administering the sales ledger.

Generally, a typical (undisclosed) invoice discounting process will involve the making of a discounting agreement with a factor. The company then supplies goods and services in the course of business and issue invoices. It notifies the factor that it has issued an invoice and the factor will advance an amount equal to the value of the book debts, less fees and less the agreed discount (which is dependent and appropriate on the level of risk assumed by the factor and is set out in the discounting agreement). It then collects the debt. The factor does not contact the customer. On receipt of payment from the customer, the company pays the whole amount to the factor. The factor deducts the amount already advanced, plus the interest accrued on the daily outstanding balance of those funds, and releases the balance back to the company.

The advantages can be:

• A quick way to raise cash.

• Undisclosed discounting is confidential and the customer does not know of the factor’s existence.

• The company retains and manages its relationship with its customer.

• The factor takes on the risks in discounting.

The disadvantages can be:

• Increased administration involved in complying with the terms of the discounting agreement.

• The interest payable can be high or extortionate in the case of bad debts.