Factoring

Advantages to factoring

Fast and Easy to Setup
Improves Cash Flow
Leverages off Your Customers Credit
No Consideration of Your Business's Credit Rating
Continuous Source of Operating Cash
No Long Term Contracts
No Personal Guarantees
Faster Payment
No Debt Creation - No Monthly or Balloon Payments
No Geographical Limitations
Can be used to replace Foreign Receivable Insurance
Comprehensive Credit Service Support
Credit Screening & Monitoring
Early Detection of Customer Service Problems
Detailed Management Reports
Professional Collections
Reduces Overhead - can replace in-house credit management
Greater Operating Efficiency
Off Balance Sheet Financing
Provides "Time Value" of Money
Retain Control of Your Business - Do Not Give Up Equity
Reduces Bad Debt
Offer Credit Terms to Customers
Meet Increasing Sales Demands
Stop Offering Early Pay Discounts
Flexibility - factor one or as many receivables as you wish.
Take Advantage of Trade Discounts from Suppliers

The little-known Solution to a well known problem

Most new businesses fail in the first year, and though under-capitalization usually gets blamed, the real reason is often poor cash flow. And cash flow needs aren't restricted to start-up operations -- many established and even thriving businesses will occasionally find themselves in a cash crunch. One solution that is rapidly growing in popularity is factoring, which is the process of selling accounts receivables to an investor rather than waiting to collect the money from the customer. Factoring is a fancy term for a basic concept that has been around for centuries. A receivable or an invoice, which has not been paid yet, has value. It is a debt that your Customer has agreed to pay in the very near future. Factors, like Gulf Coast Factoring, are investors who will pay cash now for the right to receive the future payments on your invoices. Factoring offers a number of benefits to cash starved companies. Instead of having to wait 30, 60, 90 days or longer for payment on a product or service that has already been delivered, a business can factor -- or sell -- its receivables for cash at a slight discount off the face amount of the invoice. This almost instant cash can be used to meet payroll, fund marketing efforts, or provide working capital. This cash can provide the means for a manufacturer to replenish inventory and make more products to sell without having to wait for earlier sales to be paid. Factoring isn't just a cash management tool for manufacturers. Just about any type of business has the potential to benefit, not just small struggling operations. Eighty percent of the businesses that factor today do it because they are growing not because they are dying. Factoring is especially appealing to young and rapidly growing companies. Since the process shortens their business cycle, these businesses can grow even faster. The inability 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. A typical business that extends credit will have 10 to 20 percent of its annual sales tied up in accounts receivable at any given time. Just think for a moment about how much money is tied up in 60 days' worth of receivables, and then think about what you could do with that cash if you had it on hand. You can't 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 not a loan. It is the sale of an asset. A loan places a debt on your balance sheet, and it costs you interest. By contrast, factoring puts money in the bank without creating any obligation to pay. Finally, loans are largely dependent on the borrower's financial soundness; with factoring, it is the soundness of the Client's Customer and not the Client that matters -- a real plus for new businesses without an established track record.
Factoring totaled $57.5 billion during 1993 and is utilized more than all other types of financing combined.

Factoring: Financing Your Receivables

There is an under-utilized and often misunderstood form of commercial financing available to business owners called "factoring". This type of financing can help a company smooth out their cash availability without creating a net liability on their financial condition. Although the factoring industry handles 80 billion dollars of business every year, business owners are still unsure about using it as a tool. Whenever a company offers net terms on a sale to their customer, they are in a sense lending that customer money until the invoice has been paid. What a factoring company does is purchase the obligation of the debtor (customer) in order for the company to receive funds at the same time as the invoice is produced. This allows the company to go after larger accounts while knowing that they can get paid upon delivery of a product or service. An example of this would be a consulting company that lands a large account and has to bring on additional staff to handle the workload. Can the company afford to pay the growing staff while waiting for the customer to pay their invoices? Or a manufacturer of a widget that gets a large order. Can they fulfill the order and meet their everyday cash needs? The process of factoring accounts receivables can vary in many ways. The administration of funding invoices can differ with different finance companies. Also the rate of funds in use can change based on variables of the deal like the dollar volume that will be financed and the length of time the company will be using the factor. The creditworthiness and number of customers will also play a part in determining how the deal gets structured.

Factoring - Bootstrap Financing

Factoring isn't borrowing money; it's selling your receivables for cash. It's a more expensive way of raising money than normal financing, but provides quick cash on no collateral or earnings. Financing monthly receivables of $100,000 would cost about $12,000 in yearly interest through a conventional line of credit - if you qualify. Factoring those same receivables could cost anywhere from $36,000 to $60,000 a year. But for many entrepreneurs factoring makes sense as a first step. Take the case of Slim and Jim, who make and sell scarecrows. They've found a couple investors who'll foot start-up materials, a patent search and patent application. But they need cash for materials, and to keep up with their orders. Waiting 30 days for payment isn't feasible - it's a shoestring operation. An uncle puts them in touch with Gil Bates, a golfing buddy who's a factor. Bates visits Slim and Jim's operation, evaluates their retail customers, and agrees to factor their receivables. Slim types up the invoices and sends them to Bates's office in Pasadena. Bates then enters the billing amounts in his bookkeeping system, stamps the invoices payable to Gil Bates, and sends them on. He then writes Slim and Jim a check for 75 percent of the invoice total. He'll send 20 percent more after collection, and pocket 5 percent. Slim and Jim have a good month in August, forwarding $20,000 worth of invoices to Bates. Two days later they receive $15,000. They get $4,000 later that month. If Slim and Jim's customers pay 31 to 60 days after billing Bates collects 7 percent of the profit. Up to 90 days Bates receives 9 percent of the collected funds, and if it's still delinquent after 90 days Slim and Jim buy it back. Are they happy with this arrangement? Ecstatic. Bates charges a lot, but he also provides complete credit checking of all customers, sends Slim biweekly updates on each customer's payment history, and badgers slow-paying customers. Bates has also introduced them to potential customers, and when Slim and Jim are ready, he'll help them make a transition to bank financing. Slim and Jim aren't getting rich with this arrangement, but the way they see it, they probably wouldn't be in business for themselves at all - if not for factoring their receivable. More sophisticated financing is down the road, the road factoring helped put them on in the first place.

The Creative Alternative Financing Mechanism

The word "factor" comes from the Latin "factare" meaning "to make or to do". This financing mechanism dates back to the time of Hammurabi. It has been part of the basic fabric of all trade.
The concept of "making it happen now" continues. Essentially it is the sale or assignment of a sale, trade, or accounts receivable account for immediate cash. By definition, it provides any business from start-up to mature companies (at any size), access to immediate cash and improved cash flow for expansion or growth but without diluting equity or incurring debt.
The reasons for using this financial tool are just as numerous as they are varied:

• Take advantage of trade discounts or other early payment options with suppliers or vendors and
• Ability to re-invest immediately to acquire new sales opportunities;
Since the factoring firm effectively assumes the credit evaluation risk of accounts receivable that may translate into decreased internal costs for accounts receivable administration, more efficient and effective customer accounts collection (quicker pay), and better information for management on the credit worthiness of the firm's clients;

• Increased working capital turnover as well as a reliable source of immediate financing; and
• Other financing options may not be available or timely for firm requirement(s).
The essence of the transaction is the credit worthiness of the particular receivable account, so long as the firm has marketing strength and aggressive sales efforts. Regardless of stage of development (even in bankruptcy), immediate cash may be available. Factoring is not a collection system for bad debts or even slow pay accounts. Use of factoring may, however tend to speed the payment from an otherwise slow-pay client once the disciplined payment techniques of a qualified factor are introduced. As with any "financial tool", there may be wide variations in applicable terms, conditions, and cost rates for its utilization. For example, advance rates (percentage of invoice paid in advance of collection) may vary due to account risk, industry, and factoring firm. The discount rate (fee charged by the factor for the financing) may also vary by actual risk in the account, industry, and/or factor firm. Transactions may either be "recourse or non-recourse" (return liability or guarantee of collection from the firm) which may take the form of merely replacing a receivable if it reaches a previously agreed upon age. All of these variables then come together in a "risk evaluation" cost rate or fee for the factoring service. As with any type of financing, the greater the perceived risk, the greater the cost for the service. The range for the first 30 days might be expected to be 2%-7% of the gross value of the account financed, with 5% being typical.
There may also be a wide variety of other terms and conditions in the transaction such as:

• Minimum invoice amounts (i.e., $200 - $500), minimum monthly volumes (i.e., $10,000 - $500,000), and/or time period commitments (i.e., 6-12 months).
• Notification and non-notification to the receivable account that a factoring transaction has occurred.
Just like all financing options, the business firm must evaluate its own individual needs and requirements including a focused evaluation of all actual or potential advantages versus the costs in the transaction. In most circumstances and at every stage of development, factoring, if properly utilized, can be a very valuable financial tool to achieve expanded sales and company growth. Not all factoring companies are alike, often with wide variations in terms, conditions, and rates depending on your firm's needs and accounts receivable (as well as size and geographic coverage's -local, regional, and national).
Wayne Caskey, Executive Vice President, Reservoir Capital Corporation, Baltimore, MD