Netting Expands to Factoring
Today’s web-based netting systems offer a wealth of opportunities to further develop corporate financial processes and make group-wide operations more efficient. For example, during the past few years, OpusCapita has worked on a netting-based factoring solution in co-operation with its customers. The experiences gained have been most positive.
The well-known principle of factoring remains the same but the composition of the three players has changed. In this new kind of factoring, a subsidiary sells its invoices not to a finance company but to its own parent company in exchange for money. This is becoming popular within large groups.
As described in the gtnews article The Netting Revival, technology has rejuvenated treasury interest in netting as a cash management process. Netting means that instead of having several currency accounts and pondering over currency changes, the subsidiary sells its internal invoices to the group treasury in a risk-free way through the netting system.
Extending netting to factoring improves risk management. The group treasury buys the internal sales invoices from the subsidiary and takes on not only the currency risk but also the credit risk at an early phase of the process.
As an example, when factoring with a finance company, the subsidiary (the seller) usually gets 80% of the value of the sales invoices right away. The remaining 20%, with expenses removed, will be paid only after the finance company has received the payment from the buyer. When factoring is carried out within a group, payment is always guaranteed. The subsidiary gets 100% minus the factoring fee at the agreed time. This is an example of how our customers use factoring.
The additional benefit of factoring is that the subsidiary always knows exactly how much it gets from the group treasury and when, regardless of currency changes and the cash position of the other subsidiary. This makes the subsidiary’s financial position lighter since it might not be able to carry the high risk. The parent company, in turn, is usually in a more solid position to handle the possible risk. The solution is especially suitable for shared service centres (SSCs) or companies with a centralised buying function.
Adding third parties, such as established vendors, to the netting and factoring process can be a fascinating idea. Technically this is fully possible but, as a process, requires careful investigation.
Before factoring is implemented internally, there are several details that the subsidiary and the group treasury have to agree on. For example, does the seller get the payment right away or does the seller have to wait until the group treasury has received the payment from the buyer?
To cover its expenses for providing the service, the group treasury charges a factoring fee from the seller. Alternatives are usually a fixed price or a fixed percentage of the total of the sales invoices.
Whereas large corporations prefer to have a netting system with factoring implemented locally, smaller groups can benefit from these functions without buying a system of their own. They can acquire the solution as a service. For example, starting this autumn, OpusCapita will extend its service offering to cover netting, too.
The implementation and use of netting combined with factoring could not be easier. Implementation is fast, ideally in the plug-and-play style. The application is used through an internet browser, which eliminates the need for installation and technical knowledge at the customer’s end. Instead of large investment, the software is paid for at regular intervals according to actual use.
When talking about internal factoring, some risks are not very likely to occur. These can include external fraud by clients, counterparty credit risk related to clients and risk covered debtors.
Operational risks, such as contractual disputes, are relatively easy to avoid. For instance, by using a dispute handling function, disputes can be solved within a system. The technological development that has occurred during the past 10 years has generally reduced ICT-related risks.
However, legal, compliance and tax risks cannot be ignored. Laws and regulations in the countries, where entities are located, need to be studied before implementing internal factoring.
Netting, when combined with factoring, can be used as an in-house operation between a subsidiary and a group treasury. The process provides several benefits. Internal factoring improves risk management and makes the subsidiary’s financial position lighter. The solution is especially suitable for SSCs or companies with a centralised buying function, and it is an alternative worth some serious consideration when a corporation wants to further develop its financial processes.
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