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 lock box 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

(from the May 1999 edition of Credit Today)

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.

Robert Holt is President, Baltimore Credit & Collection Services, Inc.