By  on April 16, 2007

To help clarify the differences between factoring and credit insurance, WWD talked with John Marsha, vice president and business development manager of the international division of CIT Commercial Services.

WWD: How do the credit coverage and deductibles work in each situation?

John Marsha: A factor typically assumes 100 percent of the "credit risk" on approved and undisputed invoices. Credit risk means the customer's failure to pay an approved invoice on its due date solely as the result of the customer's financial inability to pay. Under a factoring agreement, the supplier typically does not have to satisfy a deductible.

Credit insurance typically covers from 80 to 90 percent of the invoice value and usually has a deductible. A typical deductible would be anywhere from $10,000 to $35,000 based on $10 million of annual insured sales. In addition, credit insurance typically requires "non-qualifying losses." This is a minimum loss threshold that does not even erode the annual deductible.

WWD: Who owns the invoice?

J.M.: Under a factoring agreement, the factor purchases the approved invoices from the supplier. The factor is "incentivised" to collect the invoices, as it owns the invoices. Ninety days after invoice due date or earlier upon the occurrence of an insolvency event, if the invoice is undisputed and remains uncollected, the factor typically pays the supplier 100 percent of the amount due.

Under credit insurance, the supplier owns the invoice and typically handles its own collection efforts. The supplier typically has up to 180 days from the date of shipment of the first covered invoice to pursue collections, after which it must turn the invoice over to the insurance company to pursue payment. What many people don't realize is that at this point, the supplier has to reimburse most insurance companies for legal and collection fees, which can add up to 15 to 25 percent of the invoice value.

WWD: What is the pricing structure?

J.M.: Credit insurance often requires up-front payment based on a company's estimated annual sales.

Factoring has more of a "pay-as-you-go" approach. Your factoring commission is based on the value of your monthly approved invoices. If you are an outerwear supplier, and you have a slower than expected winter due to warm weather, your sales may be down. With factoring, the amount of your factoring commission would be variable, and would decrease proportionately to your sales.

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