For a long time the adage, "The more things change, the more they remain the same" seemed particularly apt for factoring. Factoring, a flexible credit and collection service based on the purchase of clients' accounts receivable, until recently employed essentially unchanging techniques and market approaches. Like Tennyson's brook, factoring seemed to go on forever.

Factoring's methods continued as they had for decades because they worked so well for so many clients. In fact, the basic approach to factoring was employed in the U.S. as far back as the colonial period. over 200 years ago, factors on this side of the Atlantic guaranteed the payment of imports from European manufacturers seeking to sell their products in a strange land.

Through the years, factoring has been an accepted and essential financial service at many companies--apparel and textile firms in particular.

The period from 1900 to about 1970 can be considered factoring's "classical age." Characteristics of that era include the following:

* The factoring community consisted of a large number of suppliers, most of whom addressed only small segments of the market;

* The market for factoring services was dominated primarily by textile wholesalers and manufacturers. They benefited from factoring's primary capabilities of collecting on the accounts receivable of a large base of customers in a timely manner, and providing working capital in the form of advances against clients' accounts receivable--a feature particularly useful for clients whose manufacturing and sales periods are highly seasonal;

* Factoring volume in the U.S. rose steadily but not dramatically;

* Factoring made few inroads outside of the traditional markets, and broad-based marketing of factoring was virtually unheard of;

* Because the customer base within its traditional markets was relatively large, individual credit exposures were relatively small; and

* As far as their own operations were concerned, factoring companies characteristically were labor intensive and slow to adopt modern data processing technologies.

THE REVOLUTION SINCE THE "CLASSICAL AGE"

The picture has changed dramatically in recent years. over the past decade factoring has undergone fundamental changes that have forced practitioners to adjust to new ways of doing business while offering opportunities for factoring clients.

One major change has been the number of suppliers serving the industry. Consolidations and mergers resulting from intense competition in this field have led to a drastic contraction in the number of factors: In 1970 there were 30 major factors in the U.S.; today there are 15.

Meanwhile, the end-user market represented by the retail organizations buying products from factored manufacturers and wholesalers has also shrunk because of consolidations, mergers, and business failures. Yet the retail side is now the predominant client base--a reversal of the situation that existed in the "classical age." At the same time, the average size of individual credits today is much larger than it was just a few years ago.

THE MISPLACED STIGMA

It is ironic that a service as time-tested and responsive to customer needs as factoring remains such a mystery to people outside of the industries it has traditionally served.

It also frequently miffs industry practitioners that many people's limited understanding of factoring centers on the stigma attached to it as a service supposedly used only by companies who have no other access to financing. Even a cursory understanding of the range of factoring's services should indicate why it has been so long lived. Certainly factoring would not have displayed as much vigor as it has without acceptance by a large portion of the marketplace, and its use by so many companies belies the "last-resort" characterization.

FACTORING ASPECTS, ARRANGEMENTS, AND COMPENSATION

Factoring's many aspects include credit checking, setting credit lines for clients' customers, assuming bad debt risk and ledgering and collecting accounts. Factors can also provide cash advances against invoices to companies that need heavy infusions of working capital to manufacture products several months in advance of seasonal sales.

Factoring arrangements are offered in two ways:

* On an "advance" basis, in which the factor makes cash available to the client after the client has shipped goods to customers;

* On a "maturity" or "collection" basis, where the factor remits to the client the net amount of the invoices sold either on the average due date of the sales invoices or when the sales invoices are collected by the factor.

In traditional factoring arrangements, the factored client's customers are notified" that the sales invoices billed by the client to the customers have been sold and assigned to the factor; a statement instructing them to remit to the factor usually is printed on each sales invoice. In cases called "non-notification" arrangements, the client's customers are not notified of the sale and assignment to the factor and are instructed to remit directly to the client.

The factor is compensated based upon the services provided. Factoring embodies a credit and receivable management function; a commission is charged for the receivable management aspects, and interest is charged at an appropriate rate for the business risks present for credit extended. Many clients of factors never avail themselves of the credit aspects and merely call upon the factor for receivable management and collection.

MERGERS AND ACQUISITIONS OF FACTORS CONTINUE

The fast-paced financial services environment of the past several years has affected factoring as it has every other business sector.

A major trend of the past decade has been the accelerating pace of mergers and acquisitions of factoring firms, spurred by the pressures of rising operating costs and lower rates in the competitive environment of the last several years. Since 1984, mergers and acquisitions have produced firms that individually handle well over $3 billion of volume annually. Fifteen companies now dominate a market that has grown steadily to its current level of $45.2 billion in annual factored sales; the 10 largest of these firms (each with more than $2 billion of volume) hold 72% of that market.

The trend seems likely to continue. Several companies are reported to be considering selling their factoring subsidiaries or merging with others. Consolidations have benefited the marketplace--they have made factoring companies adopt more cost-effective business methods and become more efficient suppliers. While they have of course offered factors much quicker access to large chunks of business than would have been possible through incremental growth, these combinations have also provided economies of scale to businesses that certainly were ready to welcome such improvements.

It should be recognized that despite this trend toward larger factors and larger clients, the mainstay of factoring clients are still middle market companies-$5 to $10 million in sales-privately and very often family owned with the entrepreneurial spirit still very visible.

CUSTOMER CONSOLIDATIONS LEAD TO LARGER EXPOSURES

As participants in today's aggressive business world, companies making up factoring's customer base have been no more exempt from the trend toward consolidations through mergers and acquisitions than factors themselves. Interest costs and goodwill write-offs from the LBOs of recent years, especially in the retail sector, have also had a profound impact on factoring and its clients.

Factors now provide credit checking and collection services to a wide variety of businesses whose customers include some of the world's largest retailers, some of whom have higher levels of debt than ever before. The development that suppliers are now dealing with larger customers has affected factoring's outlook and business methods in two ways:

* it has reversed the mix of businesses served that prevailed 20 years ago. As indicated, the majority of factoring volume back then was wholesale business--directed at textile manufacturers and wholesalers. Today, the retail side predominates, representing some 70% of total factored volume; and

* Average individual credit exposures have become quite large. Factoring clients today find themselves dealing with large retail organizations rather than with a number of single stores or chains composed of only a few stores. The result for factors has been having to deal with more customers representing larger credit exposures.

The pressure clearly is on for the factoring industry. As noted, a lot of the impact has been beneficial; it has forced factors to become even more businesslike and responsive to customers' needs.

THE WAY IT WAS . . .

Twenty years ago, a factor's decision on how much credit to extend to customers was based on a fairly straightforward process: For customers in the wholesale area, characteristics relating to financial strength, e.g., net worth, were the main determinants. For those in retail businesses, payment histories and credit ratings were the main focus. The credit lines factors extended to wholesale clients were sometimes arbitrary, with strong reliance placed on percentages of working capital and net worth figures. Many customers in the factoring relationships of years gone by did not willingly offer profit-and-loss and cash-flow information; retail customers in particular often felt uncomfortable working with factors. Moreover, factors usually made little effort to establish credit lines that could realistically meet the customer's needs: if a customer exceeded his available credit, the client could either reduce shipments or ship the products and cover at his own risk the amount in excess of the credit line.

... AND THE WAY IT IS

Today, factoring has caught up with other aspects of financial services in adopting more varied and sophisticated credit determination and management processes. Confronted with mann, large credit exposures, factors now consider a much wider array of financial information. Cash- flows and profit-and-loss projections are especially important when the factored client's customers are the large retailers that have been created from LBOs. Because so many assets of an LBO-based company are pledged against the cash raised to buy those assets, the factor obviously has little recourse to assets in the event the firm runs into difficulties. This elimination of asset protection represents a profound change in business conditions that will manifest itself in higher commissions and interest costs to the supplier using a factor for receivable management and protection. When a major retailer misses a payment to a supplier, no wonder the trade becomes jittery.

Factors and customers now exchange information much more freely than they did only a few years ago. With more riding on credit decisions, both parties benefit when the factor can see the full picture of the customer's financial position. Where it might have been unusual for customers to provide even annual profit-and-loss projections, it has now become standard practice for larger customers to present quarterly reports.

Meanwhile, factors' credit departments have become much more diligent and attentive to the potential for the major credit losses that can result from customer insolvencies. Factors now must correlate the amount of data they need to reach credit decisions with the complexity, and magnitude of the exposure under consideration.

For example, these are some of the steps factors take today in dealing with multiple credit exposures:

* Establishing an overall credit line that meets the customer's normal needs for all clients selling to that customer;,

* Setting an overall line with the customer's agreement, beyond which the customer promises to anticipate payments;

* Establishing equal credit lines for each client selling to a customer;

* Obtaining additional support to the credit line the factor extends, including items such as,

a) some form of letter of credit,

b) personal or corporate guarantees,

c) subordinations especially if the customer holds a great deal of debt),

d) splitting the risk in some ratio between the factor and its client, or as a deductible amount the client must meet before the factor provides credit,

e) splitting the arrangement between two or more factoring companies.

It should come as no surprise that the demand for more detailed and complex financial and operational information has led factors to forge closer working relationships with clients and customers' financial officers and independent accountants. This, too, has been beneficial: it has caused factor and client to become more involved in each other's business dealings and removed much of the reluctance by customers to provide factors high quality financial information on a timely basis.

WHAT DOES THE FACTOR THINK OF THE CPA?

The CPA becomes a more important player in the new world of factoring. The client seeking to call upon the business acumen of the factor must present a business plan with historical information, probably audited, and forecasts of operations, capital spending and cash flows. Many businesses cannot develop this information on their own and must turn to their CPAs. Litigation-shy CPAs may wish to duck the additional exposures of operating in this arena. But others, recognizing the business need and opportunity can leave the safe confines of the harbor and carefully and professionally head out to sea to provide this service.

The CPA should recognize that the factor is an experienced credit grantor and will, with due diligence, send out its own auditors, and carefully look at the areas of inventory and order control before it begins to operate with a new client.

The factor wants the best information available, and the CPA is often most suited in helping to achieve that objective.

THE NEW WORLD OF FACTORING

The new world of factoring is challenging. Factors today, must be in the forefront of financial management and maintain deep commitments to client service. They must also be increasingly well educated and familiar with a variety of disciplines. The days when factors could get along primarily on experience gained from "the school of hard knocks" are gone.

Factoring's prospects are for continued consolidation of companies, diversification of services and improved operating methods. While it undoubtedly will remain a mainstay of the industries it has traditionally served, factoring is likely to see a gradual broadening of its markets as companies seek a greater array of flexible financing techniques providing additional options in an increasingly competitive world. As one of the most useful and adaptable of financial services, factoring can be counted on to serve a wide variety of clients for many years to come.

Joseph A. Debler is Vice Chairman of The CIT Group/Factoring. He is a graduate of St John's University, attended the Graduate School of Business at New York University, and has studied at Harvard University where be was a member of the Advanced Management Program. He is a member of the 475 Esquire Toppers Credit Club and the New York Credit and Financial Management Association.