Invoice Factoring Articles
A Sensible Solution In Today's Tight Credit Environment
by: Marc J. Marin
Cash flow is a business's biggest need, and when it fails to flow, there is a simple and time proven method to liquidate receivables into ready cash. Factoring is a cash flow tool that can be used by a variety of businesses because of the ancillary services it provides and the internal resources it can free up.
If you pose a question to most Americans regarding the status of our economy, you'll get a variety of answers. Despite the recent announcement that we are in the midst of a recession economists are telling the American public that there is light at the end of the tunnel and the Federal Reserve is trying desperately to keep the economy from stalling. However, start posing the question to most businesses and they'll tell you that business is down.
When the economy shows signs of a sluggish trend, one of the first things to slow down is a business's cash flow. Businesses that are not prepared to creatively raise additional working capital may be in for a rough ride when their receivables begin to trickle in.
As we all know, most banks have been stockpiling their loan loss reserves over the last several years, and with good reason. It would appear that they are going to be dipping into those reserves to help get them out of loans that they really had no business writing in the first place.
Credit at most commercial banks is being tightened almost to point of extinction, which leaves many struggling businesses with few available alternatives for improving their financial standing.
Cash flow is a business's biggest need, and when it fails to flow, there is a simple and time proven method to liquidate receivables into ready cash.
Accounts Receivable funding, a financing tool now more commonly referred to as Factoring, has been in use for hundreds of years.
Factoring is a cash flow tool that can be used by a variety of businesses, not just small struggling operations. Many businesses factor simply because of the ancillary services it provides and the internal resources it can free up.
Let's look at a quick example:
A business generates an invoice to another creditworthy business. That invoice is then submitted to the factor and the business receives an immediate advance on the gross amount of the invoice anywhere from 70 to 90 percent. The factor now waits to collect payment on that invoice. Once the factor collects, they take out the earned discount fee plus the initial advance and remit the remaining portion to the business. Obviously, one can see immediate benefits from this service. Some of these benefits include prompt payment to suppliers, meeting payroll and payroll tax obligations and taking advantage of other business opportunities.
Why would a business need to factor? If you're providing products or services to other businesses more often than not, you're financing their purchases. Typical terms range anywhere from 10 to 60 days. However, we all know that most businesses fail to pay within the generous terms extended.
What basic qualifications does a business need to have in order to be a candidate for factoring?
They must be selling to other creditworthy businesses. The product or service must have been delivered and accepted. The factor must be able to obtain a priority collateral position on the receivables. The customer may not have any rights to return or offset payment on the product or service.
What differentiates factoring from receivables financing?
In reality there are few differences. There are four several key separations between the two forms of financing.
One. With receivables financing, a lender is actually lending (not purchasing) against receivables which are reported to them on what's called a borrowing base certificate. With factoring, the factor is actually purchasing receivables (not lending) submitted to them. A factoring client will actually deliver original or copies of invoices to the factor to be purchased.
Two. The lender will not monitor the progress of the receivables. A factor has an interest in the progress (collection) those receivables.
Three. Limited or no credit assistance. The lender is making a loan against receivables. Ultimately the lender will look to other collateral to make them whole in the event of a loss. Factors make a credit evaluation on every invoice purchased. Because of this, the likelihood of collecting a valid receivable is very high.
Four. Both the lender and the factor will have dominion over the receivables, which means the proceeds of the invoices will go to a lockbox which is controlled by the lender or factor. However, a factor typically has greater protection under Article (9) of the Uniform Commercial Code. Because a factor will inform the clients' customer of the Notice of Assignment of the Receivable, this typically gives a factor a greater degree of protection should a default occur.
A nice feature of factoring is that most factors provide other ancillary services which go far beyond the borrowing base a receivables financing line provides a business.
- Let's look at some of these powerful ancillary services.
- Credit evaluation and monitoring. Factors weight heavily the creditworthiness of a business's customers. This fact allows most factors to inform their clients of potential credit issues and this can certainly help a business avoid losses. As you well know, credit is everything. A factor may also provide credit insurance and provide financing on a non-recourse basis on select customers. Almost all factors subscribe to outside credit reporting agencies such as Dunn & Bradstreet, Experian as well as industry specific credit reporting agencies.
- Receivables Management. Most factors take a pro-active approach to monitoring the receivables they purchased. They often times will discover potential problems with products or services before they become a collection or bad debt issue.
Typically a factoring client will also be assigned a dedicated account executive that will act on their behalf and appear as a transparent arm of their receivables department.
- Reporting. Most factors will provide their clients with detailed management reports on a weekly basis. Often times, these reports are more sophisticated and up-to-date than ones that are generated internally by a business.
- Unlimited Sales Financing. With factoring, the amount of funding that is available to a business is only limited to the amount of credit they extend to other creditworthy businesses. Collateral. Most factors only require the receivables themselves as collateral. This leaves other collateral free and clear for other borrowing needs.
- Speed. Most factors can establish a financing relationship in days, not weeks. As banks continue to tighten their credit policies, businesses will find it increasingly difficult to obtain the credit they once enjoyed. Factoring is becoming an increasingly popular and sometimes the only choice for businesses.
Factoring has evolved greatly over the past decade and can be very competitive with conventional financing. Most factors even participate with other lenders in workout situations or to provide the needed financing to assist a business over a hurdle.
It should be made clear that factors are not in competition with conventional lenders. There are certainly some businesses that factoring is not an ideal solution while other industries are dependent on factors for their day to day livelihood.
For businesses that can't afford to play banker to the likes of IBM, Microsoft or other companies who may also be struggling with their cash position, factoring is a sensible solution.
The next time you have a client who is having difficulty meeting their obligations, perhaps factoring should be given some consideration.
from: Monitor, January 2002
Factoring Might Not Be Right for You,
But It Could Be Just What Your Customer Needs to Pay You on Time Although factoring transactions go back to the times of the Pilgrims on this side of the Atlantic and even to ancient Rome on the other, its major impact in the U.S. occurred in the Garment District in New York City. Almost all business-to-business transactions in the Garment District still involve factoring in some fashion. Typical Client The typical factoring client often does one thing very well-provide an excellent product or service. Sales are strong, growth is rapid, and its customers are clamoring for help. The problem is that growth that may be too rapid: inventories cannot meet demand; service orders go unfilled; A/P is strung out because cash flow is poor; and taxes get backed up. Too much time is spent on crisis resolution and not enough on effectively managing the growth. The first step is often to turn to the bank. AAA Bricks goes to Home Towne Bank to ask for a credit line. AAA has had an operating account with Home Towne Bank for the whole 14 months of AAA's existence. Since its business has grown, AAA thinks that Home Towne will be able to give them a line to meet expenses and help the company grow. Home Towne Bank's credit committee reviews the account, runs the numbers through the bank's credit scoring model, and rejects the line. It determines that AAA has an insufficient history, and it views the cash flow problems as a negative. AAA then gets a tip from a colleague about Factor USA. Why would a factor be willing to help when the bank just turned down a loan? Because the bank and the factor are looking at the same facts, but each from a different perspective. While the bank looks at AAA's financial strength, the factor looks at the strength of AAA's customers (known as debtors in the factoring community). It sees AAA Bricks' growth as a positive and looks to partner with AAA to fund that growth. Longevity, financials, and the principal's history are considered to be secondary to debtor strength and the ability to get a security interest on the receivables. Benefits Financing through a factor instantly speeds up cash flow. Cash can be used to catch up with past due A/P, meet payroll, buy equipment, increase inventory, meet vendors' prompt-pay discounts, fund new projects, and pay taxes. Procedures Factor USA will review AAA Bricks' debtors using traditional credit management methods and do an overview audit of AAA's policies, procedures, financials, and principals. If approved, AAA will send all invoices to Factor USA for factoring. Factor USA will run the invoices through a verification process, which generally involves contacting a random sampling of account debtors to insure invoices are correct and proper for payment (and have not previously been paid). Once approved, Factors USA will wire AAA Bricks an advance on these receivables, which can generally be 70 to 80 percent of invoice face. Factors USA will take a security interest in all A/R and any other assets as agreed. All debtors are notified of this financing agreement and instructed to send future payments to Factors USA. As invoices are paid, Factors USA will deduct the advance amount and any fees accrued and send the balance back to AAA Bricks. Factoring & the Credit Manager Credit managers often have clients that are strung out on payments with no apparent hope of recovery. Prior to write off or submission to a collection agency, the credit manager might wish to consider referring the customer to a factor. Many companies aren't aware of the benefits of factoring, and it just might be the best alternative for all involved. In return for your help, the customer might be able to pay off your invoices out of the first funding. Instead of no or partial recovery, you get full recovery. It's Not For Everyone Factoring isn't for every company. Some are viable enough for traditional bank financing. Some are in major financial difficulty, and bankruptcy may be the only answer. Keep in mind that factoring isn't cheap; it often can be 1.5 to 2.5 percent of the amount of your receivables per month. Margins must be sufficient to cover these rates, or a short-term solution could turn into a long-term problem. But in the right situation, factoring can provide enough working capital to pay off the vendors and to grow the business.
By Robert Holt
How to Increase Cash Flow Without Borrowing
Cash flow is one of the main reasons businesses fail. At one time or another, every business, even successful ones, have experienced poor cash flow. Cash flow does not have to be a problem any more. Do not be fooled -- banks are not the only places you can get funding. Other solutions are available and you do not have to borrow.
What is Factoring?
One solution is called factoring. Factoring is the process of selling accounts receivable to an investor rather than waiting to collect the money from the customer. Oh, the Irony…
Factoring has an ironic distinction: It is the financial backbone of many of America's most successful businesses. Why is this ironic? Because factoring is not taught in business colleges, is seldom mentioned in business plans and is relatively unknown to the majority of American business people. Yet it is a financial process that frees up billions of dollars every year, enabling thousands of businesses to grow and prosper.
Factoring has been around for thousands of years. Factors are investors who pay cash for the right to receive the future payments on your invoices.
An unpaid receivable or invoice has value. It is a debt your customer has agreed to pay in the near future.
Factoring Principals
Although factoring deals exclusively with business-to-business transactions, a large percentage of the retail business uses a factoring principal. MasterCard, Visa, and American Express all use a form of factoring in their retail transactions. Using the purest definition of the word, these large consumer finance companies are really just large factors of consumer paper.
Think about it: You make a purchase at Sears and charge it to your MasterCard. The store gets paid almost immediately, even though you do not make payment until you are ready. For this service, the credit card company charges Sears a fee (typical fees range from two to four percent of the sale).
The Benefits
Factoring can offer many benefits to cash-hungry companies. Rather than wait 30, 60, 90 days or longer for payment on a product or service that has already been delivered, a business can factor (sell) its receivables for cash at a small discount off the amount of the invoice.
Payroll, marketing efforts, and working capital are just a few of the business needs that can be met with this instant cash.
Factoring provides the means for a manufacturer to replenish inventory and make more products to sell: There is no longer a need to wait for earlier sales to be paid. Factoring is not just a cash management tool for manufacturers: Almost any type of business can benefit from factoring.
Generally, a business that extends credit will have 10 to 20 percent of its annual sales tied up in accounts receivable at any given time. Think for a moment about how much money is tied up in 60 days' worth of invoices: You cannot pay the power bill or this week's payroll with a customer's invoice, but you can sell that invoice for the cash to meet those obligations. Factoring is a fast and easy process. The factor buys the invoice at a discount, usually a few percentage points less than the face value of the invoice.
The Drawbacks
People consider the discount a small cost of doing business. A four-percent discount for a 30-day invoice is common. Compared with the problem of not having cash when you need it to operate, the four-percent discount is negligible. Look at the factor's discount as though your business had offered the customer a discount for paying cash. It works out the same.
Companies consider the discount the same way they treat a sales price: It is simply the cost of generating cash flow, much like discounting merchandise is the cost of generating sales. Factoring is a cash flow tool used by a variety of businesses, not just those who are small or struggling. Many companies factor to reduce the overhead of their own accounting department. Others use factoring to generate cash, which can be used to expand marketing efforts and increase production.
Why Factoring Appeals to the Start-Up
Factoring is especially appealing to young and rapidly growing companies. Since the process shortens their business cycle, these businesses can grow faster. The ability to make more products to sell while waiting for invoices to be paid is largely eliminated. Such businesses usually net much more profit with factoring than without, even when the discount is considered.
Factoring vs. Bank Loans
So, why not simply go over to the friendly banker for a loan to alleviate cash flow problems? A loan can be difficult if not impossible to receive, especially for a young, high-growth operation, because bankers are not expected to decrease lending restrictions soon. The relationships between businesses and their bankers are not as strong or as dependable as they used to be.
The impact of a loan is much different than that of the factoring process on a business. A loan places a debt on your business balance sheet, which costs you interest. By contrast, factoring puts money in the bank without the creation of any obligation. Frequently, the factoring discount will be less than the current loan interest rate.
Loans are largely dependent on the borrower's financial soundness, whereas factoring is more interested in the soundness of the client's customers and not the client's business itself. This is a real plus for new businesses without established track records.
There are many situations where factoring can help a business meet its cash flow needs. It provides a continuing source of operating capital without incurring debt, which can result in growth opportunities that dramatically increase the bottom line. Virtually any business can benefit from factoring as part of its overall operating philosophy.
Every good businessperson must understand the concept and benefits of factoring in order to operate as profitably as possible. The following chart can help you understand the differences between factoring and other sources of funding.
Fred Coutts, CPA, CMA. All Rights Reserved.
Since 1980, Fred Coutts has been crafting powerful cash flow solutions for businesses and individuals alike, from entreptreneurs to "Fortune 500" companies. He has built a solid foundation of financial and operational experience through many executive roles, including those as CFO and Controller. Fred is well versed and experienced in finance, accounting, and business operations.
Over the years Fred has developed relationships with funding connections nationwide, both traditional and non-traditional sources to help you meet your cash flow needs.
Professional Certifications:
---Certified in Public Accounting (CPA)
---Certified in Management Accounting (CMA)
Article Source: http://EzineArtcles.com
Factoring is an Effective Financing Option For Temporary Employment Agencies
It's a familiar problem for most temporary employment agencies. Your biggest customers are loyal and financially sound, but slow to pay due to corporate red tape or a longer billing cycle. That's no problem — for them. Meanwhile, you've got your own people to pay — employees, suppliers. You need cash and you need it now.
There are many ways to generate cash flow. However, not all may be right for you. If your business is small or new, you may not qualify for a traditional working capital loan. Or you may need cash flow assistance above and beyond such a loan.
One alternative is to hire a factor. A factor is a company that purchases receivables, giving your business an advance payment up front. It is a mode of financing that can help free businesses from the cash-flow squeeze caused by slow-paying customers. As an end result, a business can generate instant capital and more easily predict and manage its cash flow. Companies in the services industry are particularly well-suited to factoring as a financing tool. Temporary employment agencies illustrate the process well. Temporary employees placed must get paid on a weekly basis but many of the clients are larger companies that may take longer to pay. Factoring can help such a firm cover its cash flow.
Despite the benefits of factoring, many businesses do not take advantage of this financing tool, either because they are unaware of its availability or due to misperceptions on how it works.
Factoring has been used by businesses around the world for more than four centuries as a respected way to manage cash flow. For example, nearly all of the financing done in the garment industry is done through factoring. Additionally, every time a restaurant processes a payment by credit card, it is engaging in a process similar to factoring, since the credit card processing company advances the restaurant the payment immediately and then collects the money. Today, it is estimated that factoring is a $100-billion-a-year industry in the United States.
Factoring works like this: A factor purchases its clients' invoices and immediately advances most of the invoice amount in cash. The remainder of the invoice amount is remitted to the client upon collection, minus a small service fee. Ideally, the fee should be all-inclusive and not exceed from two and a half to four percent, based on the credit and collection characteristics of the client and its customer base. In selecting a factoring company, it is important to have the factoring firm specify up front if there will be any additional processing, administrative or other hidden fees in addition to the percentage charge.
Invoices can be purchased individually but usually are processed in batches as part of an ongoing account. Depending on the factor's scope of service and the needs of the client business, a factor can handle other administrative tasks as well, such as helping keep a company's accounting up to date, assisting with collections and advising on tax requirements and other issues. For a small business with a lean staff, these services are worth consideration.
Is factoring right for you? Traditionally, this mode of financing works best for small to mid-sized companies that don't have much collateral yet or start-ups that haven't developed an established relationship with a bank. In the latter case, it can be the temporary financing measure that fills in until a working capital loan is possible. Factoring also fills a need for rapidly-expanding companies who are outgrowing their operating capital.
by: Greg Curtiss
Freight Bill Factoring
Cash flow can make or break the success of any trucking company. In rough economic times, however, getting paid quickly for every load you deliver takes on a greater importance. Most trucking companies, especially owner-operators, cannot afford to wait 45 to 60 days or more to get paid for their freight bills. It costs money every day to keep a truck on the road.
It is not uncommon for freight customers to give an advance on a load so truckers can pay for fuel and other trip expenses, but often that is not enough to keep cash flow in balance. Taking a cash advance is really nothing more than a short-term fix to overcome greater financial problems. So how do successful trucking companies break through their cash flow crisis? The answer is freight bill factoring.
Many trucking companies have realized the benefits of factoring their freight bills in order to establish a long-term positive cash flow solution for their business. Factoring freight bills is nothing more than selling them at a discount to a third party, known as a factoring company, in exchange for immediate payment. And in return, trucking companies can heal their cash flow pains almost overnight, enabling them to put more money back into their business, maintain their operation and fuel growth.
The factoring business is nothing new, and there are dozens of well-known factoring companies that specialize exclusively in the trucking industry. But not all freight bill factoring companies are the same. Choosing the right factoring company for your business takes research, and here are a few important things to know before you start gathering information.
I Hate My Banker
Factoring: A method for companies to convert accounts receivable to cash by selling them to a factoring company (a "factor"). Typically the company sells the receivables outright. But factors these days offer services ranging from classic factoring to flexible loan programs. A growing business may outgrow its bank. That's no slight to the banker. It's just a fact of life. A good banker knows the bank's limitations and will work to preserve at least part of the relationship. That's what banker Fran Mitchell did when bank examiners balked at a loan to one of her best customers. Thinking fast, she came up with a solution that served both the customer and the bank. By putting her customer's needs first, she turned a bad situation around to the benefit of her borrower and her bank.
Fran Mitchell's firm handshake and jovial greeting belied her indigestion. Her lunch appointment, Bobby Marlin, could tell she was agitated, but didn't press the issue. Marlin's company, Family Electric, was one of Mitchell's biggest customers. She needed both hands to count all the valuable customers Marlin had referred to Valley Bank. What Mitchell had to say wouldn't be easy. Well, out with it, she thought to herself.
"Bobby, I can't loan you any more money." It was so unexpected, Marlin made her repeat it. "Nonsense," he said. "I give you a financial statement every month. You get a monthly list of my accounts receivable and inventory. I have put up everything I own as collateral, including my house. My company is growing. It's making money. I've never missed a payment. Are you nuts?"
Family Electric was a successful wholesaler of electrical supplies. The company was best known to the public for its showroom, where it sold appliances and light fixtures. But most of the company's sales came from the wholesale operation. Its customer base was comprised primarily of smaller contractors in commercial construction. The company sold everything from utility lines to airport lighting. These customers usually bought on credit, and paid their bills monthly.
As the company grew, so did its inventory needs. To get cash, Marlin borrowed against accounts receivable. Valley Bank had been eager to provide that credit. Until now. "So what's the problem?" said Marlin. "I can't be even close to your legal lending limit." Mitchell found her predicament difficult to explain. Last week, in a routine examination of the bank's loans, regulators tagged the Family Electric loan as "substandard." It had nothing to do with the company. Valley Bank just wasn't prepared to keep tabs on such a large inventory loan. "Oh, there's still some room left from a legal lending standpoint," the banker said. "The problem is that we aren't properly dealing with the mechanics of taking inventory and accounts receivable as collateral." Marlin was perplexed. He had given the bank a security interest in all of the inventory and the accounts receivable. The bank had filed the required notices with the county and state. What else could they possibly do?
"Lenders have to be especially careful with inventory and accounts receivable," Mitchell explained. "A properly managed inventory and receivables loan would have a lot more controls than we currently utilize on your credit line."
Specifically, she explained, regulators wanted the bank to make unannounced inventory inspections and collect receivables directly from Family Electric's customers. That's a normal arrangement. The classic revolving credit line generally involves borrowing and repaying daily. Customer repayments constantly lower the amount owed on the loan and new receivables provide additional collateral to borrow against as the company grows. This constant cycle of borrowing and repayment is why they call it a "revolving" credit line.
"That's ridiculous! That kind of paperwork would drive you crazy," Marlin said. "Why can't I handle my own money?"
Under the bank's current arrangement with Family Electric, the company handled its own collections, and made monthly payments to Valley Bank.
"Bobby, I know it's not your style. But look at it from their point of view. The way we've got it set up, you could collect from your customers for a month, run up your credit line, and take off to Mexico with your secretary."
"I see your point," Marlin said. "I couldn't sell my house without paying you because you have a mortgage recorded at the courthouse. But when I collect accounts receivable, I could pocket the money and disappear. But man, what you're describing sounds like a pain in the neck. "Well I don't like it very much, but if that's what we have to do, let's do it," Marlin said. "My customers have some large contracts coming up and I'm going to need a credit line increase in the next 60 to 90 days."
Mitchell shook her head. "I'm sorry Bobby. I can't increase a credit line that the regulators have already taken exception to."
"Look Fran, I've done everything the bank has asked me to in the past and I will continue to do so. I think it'' a giant pain in the butt, and I don'' understand it very well, but if I have to do more, let'' do it. Just give me the forms and tell me what to do."
Fran did not immediately respond. She picked at her salad and took a sip of her iced tea. "That's what I've been trying to tell you Bobby. Our little bank just isn't equipped to do all the things that the regulators want. My staff can't monitor your loan the way we should. There's no one on staff who would know a transformer from a television. I've never done one of these loans and neither has the bank's lawyer.
"Bobby, here's the deal. My boss tells me that if I lose your account, I'll lose my head. My examiners tell me I can't loan you any more money. I know you need the money. Let me see what I can do."
This story has a happy ending. Mitchell realized that Valley Bank was not prepared for an inventory/accounts receivable loans, so she turned to someone who was: a commercial factor. Although many business owners blanche at the thought of factoring because it tends to be expensive, Mitchell was able to get her customer a good deal.
In addition to Family Electric's good credit record, Mitchell threw in some free banking services and a small irrevocable letter of credit, allowing her customer to cut his costs even further.
The next lunch went much better. Mitchell reported that she had arranged through a factoring company for a credit line three times as big as the one Family Electric had at Valley Bank. The cash advance formula under the new loan would be much more generous than the bank had allowed.
Customers would make payments to a lockbox at the bank, to be forwarded to the factor. But Marlin would be able to monitor the whole process by computer.
"This isn't factoring in the classic sense," Mitchell said. "You won't be selling your receivables. They're only serving as collateral. You'll actually sign a note and be liable for repayment."
Marlin was skeptical. Despite the bank's efforts to keep his costs down, the factor wanted an interest rate of prime plus five percentage points. That was much higher than the prime plus one percentage point Family Electric had been paying at Valley Bank.
"Now Bobby, don't have a coronary. With this new line you will pay down your borrowings every day, not just monthly like you do now. That will help you keep your average balance much lower than you do now. So even though your rate is higher, your actual interest costs will probably come down.
"I took the liberty of scheduling an appointment. The factor people said they'd like to come out tomorrow to look at your operation and they claim we can close in two weeks. All we need is your permission to move forward."
Marlin had looked at factoring before. And he hadn't been able to get even close to the terms Mitchell had negotiated. He also knew that the clumsy arrangement he had with the bank forced him to carry an average checking account balance of $100,000. The factoring arrangement would allow him to reduce that to almost nothing.
The real selling point, however, was that the available credit would grow with the business, with automatic increases as more receivables were added to the books. The change also would free up the company's bank credit lines for additional equipment or building expansion.
"All in all, Fran, I'd say you get an A+. I'll buy lunch."
* * * * *
Too often, commercial factoring companies are looked on as lenders of last resort. Actually, factors — from the Greek word "factare," which means to make or to do" — help businesses make and do more by providing liquidity.
Factors are good at what they do. They have the staff and procedures required to handle the complex chores of monitoring inventories and receivables that are in a constant state of flux. This expertise allows them to safely make loans that many banks simply cannot handle. Bobby Marlin was lucky to find a banker willing to give something away to keep a customer for the long term. Most bankers are averse to sending their customers to any competing lender. It's not always easy to do what's right.
by: Ryan D. Tennyson and Bradley C. Kuhn from: The Journal of Lending & Credit Risk Management, November 1997
The Factoring Solution
When the vice president of a Reston high-tech firm arrived at his home office after a Las Vegas trade show, he was exuberant. The three-day show had been a smashing success, and he was looking forward to developing a solid roster of new clients from the product orders he'd received. But fulfilling these new orders meant more supplies needed to be purchased, employees would be working overtime, and shipping and handling costs were about to skyrocket.
The vice president actually had a dilemma on his hands despite his Vegas success. Instead of launching into a new level of sales, he would need to spend the next few weeks looking for capitalization while holding off expectant customers. The vice president turned to a little-known capitalization vehicle for help. Unable to borrow from a bank, he went to an entrepreneurial factor for the capital he needed. Using the completed Vegas orders as collateral, he quickly secured the cash needed to fulfill customer expectations. And as it turned out, fulfilling the Vegas orders led to the high-tech company being able to establish itself with a banking institution to avoid ever being short of capitalization again.
How is it done?
But what was the "entrepreneurial factor," and how common – and safe – is it to do business with this kind of finance provider?
The practice of factoring has literally been around for thousands of years. Whenever someone is owed money, there has always been someone else willing to take a cut of future income in exchange for providing "instant relief" to the owed party. The most common example of a modern receivable finance vehicle is the credit card. A merchant gets paid by the host bank before its customer gets around to paying the bill, and the bank takes a percentage of the customer's payment.
The factor works in similar fashion, providing capital either by purchasing the asset value of a receivable (non-recourse) or by making a loan with the invoice as collateral (full-recourse). When the factor purchases the value of the receivable, it takes the credit risk that the invoice will be paid, while the client retains the performance warranty on the work done for the customer. The factor usually performs a credit check on the customer before deciding to purchase the receivable. When a factor makes a loan against an invoice – which typically occurs when customer credit is not favorable – its client continues to assume the credit risk, and will be liable for non-payment.
How common a practice is this?
Since the factor often helps provide financial discipline and for its clients, it isn't uncommon for a bank to recommend a factor to a client seeking a loan without the adequate credit record. Banks see factoring as an interim solution to inadequate credit. And even institutional banks have begun to offer the kind of lending services normally associated with factors -- accounts receivable financing.
"Sometimes a company can't pursue conventional financing," says Michelle Douglas of Southern Financial Bank. "Factoring allows companies the opportunity to secure short-term working capital to get them in a better position to secure a banking relationship."
An honest – and smart -- factor wants its client to eventually graduate to conventional banking relationships. A company which cannot establish an exemplary credit history can eventually become a bad risk for any financial partner. The factor's ideal partnership would be with a new or reorganized company with a bright future – one which probably won't include depending on a factor for more than limited period.
How does the perception affect a business?
"The general misconception is that the only time to use a factor is when your company is going out of business" says Gary Honig, President of Creative Capital Associates, a Maryland-based factor. "Exactly opposite is the truth: Factors want to work with companies in a growth mode. They are as unlikely as any financial institution to invest in a failing company". The perception of the factor as the last line in a shaky financial defense has persisted largely because of the unregulated status of the factoring industry. Some factors are private individuals with huge cash bankrolls, while others are public companies accountable to shareholders. Until recently the use of a factor was thought to indicate that a company had fallen to the bottom of the financial pecking order.
What has changed?
But the factoring industry itself is in a growth mode, and the marketplace is shaking out the shady players through a combination of competition and sound operating procedures. The factors watch each other closely – they interact constantly, providing assistance to one another as banks do – and they aren't shy about comprehensively learning their clients' business and industry. Some factors often specialize narrowly, dealing with just medical or construction receivables, for example. And while they often deal with companies unable to make a deal with conventional bankers, the typical factoring company doesn't take on all comers. Far from it. Since it will operate as a de facto partner or investor by assuming the risk of a company's receivables, it's in the interest of the factor to take on clients who are growing, solvent, and ambitious.
"It's critical to work with a factor who understands you and your business plan," says Honig. "Most factors aren't willing to take on just anybody, and you should be wary of any factor who gives the impression that they're willing to business with everybody. Normally, you shouldn't use a factor beyond the growth spurt that initiated the need for one. You use a factor to get to better terms."
And terms, of course, vary greatly.
The factor generally discounts the full face value of an invoice by a certain percentage. Rates are generally determined by risk and volume. High risk is more expensive, low risk less expensive. Low volume, measured in dollars per month financed, is more expensive, high volume less expensive. If a client can guarantee it will need factoring for a specific amount of either time or money, the rate can also be lowered. Some factors provide annual APR rates which are tied to the amount of financing outstanding, while others simply discount invoiced amounts between two to six percent.
Partly because of its unregulated nature, it is rare to find two factoring companies which operate entirely alike. Each factor has its own method to sort out credit issues, notify a client's customers, and verify that invoices are real and collectable. Some factors will also operate as a collection agency.
So what's the good news
Even hardcore skeptics of factoring admit there are some unique benefits to the practice. First and foremost is equity, which remains unchanged on the company balance sheet even when deals with a factor are struck. A conventional bank loan or credit line shows as an on-going liability on company books. Also, entering into a relationship with a factor – and getting capital -- takes only a few days. For companies wrestling cash flow crunch, the immediacy of potential capital is often the deal-maker.
"We've been operational for over twelve years, and recently we got into a pinch due to some new and large accounts," notes Doug Beaver, owner of Gaithersburg-based Amguard Security Services. "Rather than going through a total re-application of our bank line, we used a factor for short-term working money until the new accounts became self-payable. Having never used a factor before, I was surprised how quick and painless the process was." But no aspect of the factoring business is as highly regarded as its flexibility. Compared with the usually rigid practices of both your neighborhood and downtown bank, a factor can be just the fresh opportunity a business needs to blossom.
"Our business grew ten-fold in less than two years," says Anthony Wright of Virginia-based P&W Surplus Office Movers, "And factoring allowed us to sustain that kind of growth. It gave us flexibility."
By Sean Harris
Mr. Harris has been widely published in newspapers worldwide (Washington Post, Baltimore Sun, Seattle Times, Montreal Gazette, Toronto Globe & Mail, London Times, Houston Post, etc.), and has written about information technology and DVD for a variety of national trade magazines (Information World, the SIGCAT Discourse. Etc.). He is the Creative Director for the PR and marketing company Pink Piglets Ltd., based in Washington D.C.
Debt Financing For Your Company
There was a time in the old days when going to the bank was the only way to get outside capital for your business. These days with the explosion of raising equity investment, many of the guidelines for running a company have been revolutionized. Unfortunately this new phenomenon is only true for companies with super "star power", because these companies have potential to create sky-rocket return earnings.
For everyone else, sticking to fundamentals is where it's at. Building your company incrementally, following a pre-prepared business plan, watching expenses, and increasing sales. When your company moves beyond its launch, it begins to operate much like a bank. On the financial side you will be making credit decisions involving your customers. Some will have to pay C.O.D., some you will extend net 30 day terms. In this sense you are now becoming a banker for your customers.
Without getting into how inexpensive debt financing ultimately is compared to equity (try 20% annualized interest versus 20% ownership lock stock and barrel), in certain situations the time honored tradition of borrowing money can be the best solution for increasing growth or starting a company.
By knowing what commercial finance companies look for, you will become a much more attractive prospect.
Concentration - This means putting all your eggs in one basket. Avoid going out and making a large sale to a customer and then not continuing your sales effort to find more customers. The risk of a problem developing with your main customer, or for whatever reason they are no longer buying from you can obviously be detrimental to your success. Finance companies look for incoming revenue to be spread evenly over a number of customers.
Creditworthiness - Who are you lending your hard earned assets to? What kind of due diligence do you perform on new customers? The challenge here is whether to accept a lucrative sale with a company that could never get credit from any type of finance company. You are essentially telling yourself that you know better than the banker about loaning money. Finance companies will respect a business owner that has a thorough credit checking process and a number of stable credit worthy customers.
Book keeping - While some businesses send out all their accounting to outside agencies, it is helpful to have a qualified book keeper on staff. When it comes time to seek financing, being able to produce an instant fiscal snapshot of your company will show the sophistication of your operation. Finance companies appreciate businesses that keep a close eye on their books.
Taxes - Pay them. Using the Internal Revenue Service as your funder becomes expensive. Whenever you work with a finance company, you will be pledging assets as collateral, thus the nature of debt financing. When you fail to make tax payments, the government steps in and places a lien against those same assets essentially stepping into first position. This leaves the finance company with money outstanding to your business and no collateral to back it up. This places your entire relationship in default. When going to closing on financing expect to sign a form that allows the finance company to receive duplicate correspondence from the IRS. This is standard procedure to track tax problems. Owing taxes does not mean you cannot get financing. It is entirely possible to receive a subordinated debt agreement from the IRS which allows the finance company to work with you unencumbered.
Bankruptcy - If you have ever entered into a bankruptcy proceeding whether personal or business, own up to it right away. It will come out, and being up front about the circumstances will enhance the necessity to overlook the past difficulties.
Applications - Finance companies ask for a variety of information when performing their due diligence. Do not be alarmed, they are not trying to steal your secrets. They need to feel comfortable with you and your company. Each company has its own threshold for fact checking. Invariably the finance companies that do the most thorough job are the most reliable and safest to do business with. Finance companies like working with a business that takes the time to put a loan package together in advance of asking for financing. Typically you can start with; Interim Balance & Income Statement, Interim Profit & Loss Statement, Last Year End Statements, Accounts Payables Aging Report, Accounts Receivables Aging Report, and of course Tax Returns.
Contracts - Be prepared for onerous language. Finance companies cannot sugar coat the reality that if something goes wrong they need to exercise their rights. They have to go into the relationship always thinking that the absolute worst case scenario will unfold. Once a finance company finds itself being defrauded, stolen from or payments not made without explanation, it's too late to insert stronger language for protection. By and large the language is standardized and walking from a deal to start shopping for less demanding legalisms won't produce much. Remember this, a contract is just paper in a file cabinet until you default on your agreement. Stay within what you agreed upon and all the tough language won't matter. Even if you start having financial difficulties, get in touch with your finance company immediately. You can greatly reduce the chance of default by showing that you are pro-active with your situation.
Using the money for the right reasons - This sounds obvious but in certain cases it can be highly relevant. You hear a lot about going to the right Venture Capital Firm that would handle your type of investment. In some ways that holds true for debt finance companies. They tend to work within industries that they feel comfortable. Additionally the type of financing company will depend on your plans for the money. If you are trying to set up a new business infrastructure, then a working capital line of credit is not your best option. You will probably do better with a term style loan that will allow you to amortize the expense over a period of years.
Management Integrity - Also like equity investment, get a good team together and hold onto them. Finance companies raise red flags when a long time Financial Officer who has been the contact person at the company since the inception of the relationship all of a sudden leaves without explanation. Again, always fearing the worst, the finance company could unjustly feel that something untoward was afoot and begin to scrutinize your account more closely. Even though finance companies are not part owners of your business, they are partners in your success just like your good customers. Keep them abreast of breaking news.
Be Professional - Answer calls and messages expeditiously, be prepared with information, show up on time. When its crunch time and you need an extra fifty thousand dollars for a week to get a better deal from a vendor, you would be surprised how much mileage you can get by being a courteous and thoughtful customer to your finance company.
from a speech given at SmartStart 2000 Albany Law School Science & Technology Center
Growing Faster Than Your Cash Flow?
Let Factoring Fund Your Next Expansion
Why wait weeks or months to get paid by your clients when you can access your money in a matter of days by factoring your invoices. When a business factors their invoices, they are allowing a third party to purchase their invoices at a discount price. This discount is considered the third party’s fee.
If your business receives orders from customers on a regular basis, but has to wait 30, 60, or even 90 days for payment, you maybe experiencing a crunch in your cash flow. Factoring gives you the opportunity to access your cash within days not weeks or months. The growth of your company depends on whether or not you have the working capital necessary to finance your expansion.
When a factor purchases a company’s invoice or invoices, no interest is ever charged. This is because factoring is considered an outright purchase. When a company sells their invoices to a factor, they can expect to receive an advance up to 90% or more of their accounts receivable. The business gets this money immediately and the factor makes a fee for this service, turning the transaction into a win-win situation for both parties.
Factoring is no longer a business tool used by the large Fortune 500 Companies. Small to midsize businesses are receiving tremendous benefits by implementing factoring as part of their financial strategies. If your business is growing at a faster rate than your cash flow, maybe it’s time to explore an alternative solution such as accounts receivable funding.
By Marty Milan
From Ezineearticles.com
Tech Startups Find A Friend In Factors
by: Paula Moore, Business Journal Senior Reporter
from: The Denver Business Journal, Small Business Insights July 6, 2001 print edition
Many young technology companies looking to improve cash flow quickly are turning to factoring as a way to get back on solid ground.
Factoring — when a financial company basically "buys" a company's accounts receivables — is becoming especially popular as more startups fall prey to a slowing economy. The Invoice Bankers Inc., an Englewood-based factoring company with national reach, has noticed inquiries about its service jump in the last six months.
"The more the economy slows, the tighter banks get with loans and the more business we do," said Mike Stanki, head of business development at the Westminster office of Commercial Finance Group. The Burbank, Calif.-based company has done $30 million a year in business here in recent years.
The practice has become so popular here that even Wells Fargo & Co., the Denver area's biggest bank, has embraced it through its business-credit subsidiary.
Factors buy their customers' invoices, or accounts receivables, for cash. The factoring company purchases an invoice for a sum that's most of the invoice amount. Then the factor gets the money due on the invoice and pays its customer the remainder of the invoice amount, less a fee of usually 2 percent to 3.5 percent.
Factoring can sound like a get-rich-quick scheme, but when handled by qualified practitioners, it's not. It can be a good way for companies that can't qualify for bank loans to get the cash they need to operate and grow.
It's especially attractive to companies that must spend money faster than they bring it in, such as temporary employment agencies that pay their temp people weekly but get paid by customers only once a month.
When invoices become past due, though, some factors won't collect on the bad debt, so as not to interfere with their client's relationship with its customer. But others do. Commercial Finance, for example, has a whole collection department in Las Vegas.
"We finance the receivables while our customers wait to be paid," said Greg Curtiss, Invoice Bankers' president, and also a lawyer, certified public accountant and former venture capitalist. "We don't look at our customers as much as we look at their customers — who's paying them. The key is the quality of the credit of our customer's customer."
Locally based Invoice Bankers, which started in 1983 as CS Capital Corp., got into factoring in the early 1990s and now does that business nationwide. Most of the small and medium-size companies it serves, whose monthly receivables are generally $15,000 to $500,000-plus, are located outside Colorado. Those clients range from dot-coms to temp agencies, but as many as one-third are in the construction business.
"It takes forever for subcontractors to get paid," said Curtiss.
Commercial Finance's stable of clients includes tech concerns such as software and information technology companies, but also trucking firms, an optics manufacturer and even a farm.
"Our clients are typically companies with high-growth opportunity that can't get bank financing," said Stanki. "A bank would say you're a good company, but your ratios don't fit our lending requirements."
Factoring's Roots
Factoring has a long history, though it's not nearly as ancient as another old practice that's getting new interest: bartering. Factoring started about 200 years ago in New York City's garment industry. Banks were, and still are, reluctant to lend money to clothing makers because of their business's seasonality and, therefore, riskiness.
Over the years, factoring's reputation became sullied because many companies used it only if they were in financial trouble. Since the practice expanded beyond the garment business and New York 20 years ago, however, it's become more sophisticated and its image has improved. Even Xerox Corp. Recently raised $450 million based on its receivables. Factoring is now a $100 billion-a-year business.
But being a successful factor can be a mixed blessing. Its customers may outgrow it and move on to other sources of financing such as banks and venture capital. "We hate to lose clients," said Curtiss. "But we like to see them succeed."
It cost you nothing to find out if Invoice Factoring is right for you, apply for your free invoice factoring quote today
