A B C’s of FACTORING
Accounts Receivable Advances
A Commercial Financing Tool
Working capital, is the “energy” that moves in and out of a business. Most business managers would put forth the notion that cash flow is at the top of any business priority list. Perhaps, there is nothing more frustrating for a business owner than to have his/her business not reach its potential due to the lack of working capital. Losing opportunities to expand, unable to make product sales, late paying bills and taxes, stops in production - while giving customers interest free loans on delivered services or products doesn’t help. This is precisely what happens when companies wait 30, 60, 90 days on unpaid invoices. As a business experiences slow cash flow the need to examine the company’s financial structure is often magnified. Nationwide, hundreds of businesses use factoring as a useful and alternative financing tool to meet this problem.
Factoring financing is a much larger segment of the financing industry
than many recognize. According to BCR’s World Factoring Yearbook,
the total of all reported annual factoring in North America in 2003 was
$96 Billion.
How does Factoring work?
When a business produces a product or a service for another business they send a bill (invoice) for that service or product. The business has created an asset to draw against (the invoice). A factoring company can advance against invoices providing a business with immediate funds, as a business seeking capital, sells their invoices for working capital needed.
Simply stated, a business sells their accounts receivables to a third
party (Factoring Company) in exchange for immediate cash.
Accounts Receivables Financing (Factoring) is an alternative to other
asset based lending, working capital loans, and small business loans.
Unlike traditional capital sources, factors are not concerned about the
company’s credit or most other requirements important to traditional
lenders. The factoring company’s main concern is the credit worthiness of
the invoiced customers of the business seeking capital.
In this article, “Factoring”, “Accounts Receivables Funding”, “Invoice
Financing”, and “Receivables-based Financing” are terms used
synonymously. This article deals with the Factoring industry as an
alternative source of commercial financing.
Receivables-based financing (Factoring) avoids restrictive covenants,
tying up all of the company’s assets, giving up equity, the burden of
periodic loan payments, and going through the yearly loan review
process. Factoring companies seek to help businesses who are waiting
30 to 90 days to be paid whose customers are “getting them down” and
they are spending valuable time chasing money they have already
earned. Without the cash, businesses struggle to pay their bills.
Factoring allows them to receive immediate cash but at the same time
limit the financial assistance for only the amount and length of time
needed.
Some Advantages of Factoring Financing:
Factoring companies typically present some of the advantages of
receivables-based financing as: Prompt Payment To Suppliers – Taking
Advantage Of Business Opportunities - Meeting Payroll and Payroll Taxes
On time - Generating Instant Working Capital - More Easily Manage And
Predict Cash Flow - Offer Competitive Credit Terms - Avoid Cash Flow
Problems Caused By Customers With Long Payment Cycles - Grow Your
Business Without Overhead or Getting a Partner - Pay For Your Expenses
In Relation To Sales - Have You Outgrown Your Bank’s Lending Limits?
Need Working Capital Now?
The notion that when the business needs cash,
or when there is a need for working capital,
factors have the resources
to provide immediate funding
through the purchase of the business’s accounts receivables.
Even if the business is a new company, they can provide funding for immediate needs.
They look to the credit worthiness of the company’s clients. They can provide additional capital when needed most, all without creating traditional debt.
The Invoices Financing Process:
Theoretically and simplistically, here’s how the invoice financing process works:
A business generates an invoice to a creditworthy business. That invoice is submitted to a factoring company and the business receives an immediate advance (usually ranging from 70 to 90 percent of the gross amount of the invoice) depending upon the quality and type of the credit worthiness of the invoiced customers. The factor will then wait to collect payment on the invoice. Once received the factor takes out their earned discount fee, plus their initial advance and remits the remaining portion to the business.
The Basic Qualifications to be a Candidate for Factoring:
- 1- A business must be selling to other creditworthy businesses.
- 2- The creditworthy business may be a government entity or another business.
- 3- The product or service must have been delivered or accepted.
- 4- The factor must be able to obtain a priority collateral position on the receivables.
Obviously the Factor has an interest in the progress of the receivables since they actually purchase the individual invoices and advance capital. Those not familiar with the factoring process should understand that only invoices generated from business-to- business, or business-to-government are factored, not business-to-individual or individual-to-business.
One advantage of factoring is that a business’s credit line grows as their business grows with no restrictions on use of funds, and no new debt created. In addition to their providing working capital quickly, another nice feature of factoring is that most factors also offer ancillary services.
Ancillary Services:
Some of the services that our company can provide and most good factoring companies also provide are, credit evaluation and monitoring, receivables management, reporting, unlimited sales financing, collateral, and speed.
Credit Evaluation, and Monitoring - Because factors, weight heavily, credit worthiness of a business’s customers they can advise their client of any credit issues.
Receivables Management – Most factors watch receivables carefully and often discover potential problems before they become a collection issue.
Reporting – Some factors provide more sophisticated up-to-date weekly reports than are generated by a business internally.
Collateral – We only require receivables as the collateral. Other assets are free for other borrowing. Most factors only collateralize receivables.
Unlimited Sales Financing – Factoring allows the business to limit the amount of funding financed to the amount of sales or in other words the amount of credit they have extended to their sales clients.
Speed – Almost without exception, if the business will supply the information asked for by the factor, advance capital can be in possession of the business. Our company is usually able to provide funds within 3 to 7 business days. Once the relationship between the business and the factor is established, future invoices factored can result in cash over-nighted to the business’s banking account.
In some businesses factoring is not a good solution to satisfy
cash flow issues, while other industries are dependent upon
factoring for their day to day operations. Furthermore,
factoring is a sensible financing alternative solution for other
businesses. As traditional financing restrictions and credit policies
are tightened, factoring may be the best financing choice for a
business.
Many types Of Business Use Factoring Services:
Although space in this article does not permit the opportunity to address many of the Q&A - frequently asked questions – about factoring (to be addressed in a future article); it is important to underscore a few industries that regularly use factoring as a financing solution. Such industries as, temporary employment agencies, printing, manufacturing, service businesses, business machines, janitorial, job training, garment distributors, temp nursing and physician assistance, steel fabricating, trucking/transportation, furniture, consulting, environmental, telecommunications, retail suppliers, government vendors.
The benefits of factoring have been a well-kept secret for many years. Yet, factoring has evolved significantly in the past ten years and can be very competitive with conventional lending. A good factor will participate with other lenders as needed to provide needed financing in workout situations, assisting a company over a financial hurdle. BCR’s World Factoring Yearbook report of factoring of $96 Billion annually in North America underscores the significant role that factoring/ invoice financing companies play in sustaining business activity. If a business is having difficulty meeting their cash flow needs, and they meet the basic qualifications to be a candidate for factoring, they should consider an advance on their invoice as an alternative to meeting their obligations. Factoring helps businesses increase cash flow while reducing credit and collection headaches. Factoring is a sensible working-capital solution in today’s tight credit environment.
Duane H. Marchant, President
AAA Factoring Group
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801-292-1220