Factoring Question 6

If banks tighten their credit facilities, does it make it harder for me to obtain factoring?

No. Factoring that is done through reputable, well capitalized factoring companies is not affected by bank policies towards small and medium sized businesses.

Factoring is not a loan and is not about getting credit. It is about the sale of an asset that you own – the receivables – to guarantee cash flow and obtain working capital.

© 2006 Sanjeev Aaron Williams & Cashwerks All Rights Reserved

Factoring Question 5

We are a brand new start-up. Can we factor immediately?

No. You need clients. You need to supply them with goods or services under a fully completed contract. You need to have an invoice under which they are liable to pay. In that order.

For a brand new start-up, initial funding may have to come from the founders, family and friends, a line of credit, or a bank loan.

However, start-ups should talk to factoring companies and present them with a list of serious potential clients who have expressed a written interest in their product. Factoring companies do credit checks on debtors as a matter of course, and where there is an intention to establish a factoring relationship, they will often advise the start-up as to which potential clients may cause delays in paying invoices.

Once invoices are generated, start-ups can factor and the cash will be available within days.

© 2006 Sanjeev Aaron Williams & Cashwerks All Rights Reserved

Factoring Question 4

If my company is facing bankruptcy, is factoring still an option?

It could be the only option. However some funding sources will only consider purchasing receivables under US Chapter 11 Bankruptcy protection i.e. where there is a reasonable prospect of the company emerging from bankruptcy and continuing as a viable operation. This will involve negotiations with creditors about debt restructuring.

© 2006 Sanjeev Aaron Williams & Cashwerks All Rights Reserved

Factoring Question 3

How long will it take to receive the initial funding?

This varies depending on the factoring company. Since factoring is all about the speed of guaranteed cash flow, you can expect the factor to move quickly on Due Diligence, invoice verification, credit checks on the debtors and client investigation.

Initial funding should take place between 3 – 7 days after all documentation is signed. Funds are usually sent by wire transfer, but can also be sent by cheque if requested.

© 2006 Sanjeev Aaron Williams & Cashwerks All Rights Reserved

Factoring Question 2

Can I sell only a portion of my invoices?

Yes. The decision of how much to factor is up to the client. Sometimes a client knows precisely how much cash flow they need in a month and will only factor invoices up to that amount. Similarly, a client may only wish to factor invoices from a certain client every month.

Whilst flexibility is built into factoring, remember that the higher the number of receivables purchased by the factor on a regular basis, the more competitive the rates will be. Generally, invoices that are payable by a larger (rather than smaller) group of creditworthy debtors, will attract more favourable rates.

© 2006 Sanjeev Aaron Williams & Cashwerks All Rights Reserved

Factoring Question 1

Can we sell invoices that were billed before the date of the factoring contract and are still outstanding?

Yes. In practice the first funding usually consists of those invoices – provided they are to creditworthy payors and are within 30 – 45 days outstanding.

© 2006 Sanjeev Aaron Williams & Cashwerks All Rights Reserved

Types Of Factoring

When a factoring company decides to buy the invoices from their client, the factoring contract will state whether the funds supplied are on a Non-Recourse or Recourse basis.

What’s the difference?

Non-Recourse
In buying the invoices from the client, the factoring company assumes the full risk that the payor of the invoice will not pay them in full or at all. To cover themselves against this risk, factoring companies carry credit insurance. That’s why factoring companies are so interested in the creditworthiness of the ultimate payor.

Recourse
Sometimes referred to as Full Recourse. After a certain period of time, usually 90 days after the invoice was due for payment, the client will have to owe the advance back to the factoring company. In practice, the factor may set-off this amount against an advance on a later invoice which the client offers for factoring.

© 2006 Sanjeev Aaron Williams & Cashwerks All Rights Reserved

Focusing On The Best Clients

A business that is seriously considering Factoring as an important part of its cash flow strategy, needs to focus on 2 things:

Acquiring good clients – i.e. clients who pay invoices promptly, preferably within 30 days. The more creditworthy the payor, the better the discount rate the funding source will quote. It is important to remember that a funding source does its own creditworthiness check on the payor BEFORE agreeing to factor. They can therefore assist their clients in identifying potentially problem payors. This is an important service that a business client does not get from a bank.

Selling consistently to those clients - Why? Once the funding source sees a pattern of prompt payment on the factored invoices by the payor, the client may receive a better Advance rate and in due course, a better discount rate.

© 2006 Sanjeev Aaron Williams & Cashwerks All Rights Reserved

The 3 Parts Of Factored Funds

The previous post alluded to the 3 parts of factored funds:

"Having purchased the Receivables, the funding source will initially advance 75% - 90% of the invoice amount up front and will pay the remaining amount – minus a service fee – after the Client’s Debtor pays the full value of the invoice to the funding source. The service fee is expressed as a discount from the face value of the invoice. The discount varies according to the length of time the invoice has remained outstanding."

Advance
This is the dollar amount the funding source will fund initially. It is always expressed as a percentage of the face value of the invoice

Example: if an invoice of $100,000 is being factored and the funding source says it will advance 90%, the client will receive an initial funding of $90,000.

Reserve
This is the dollar amount held back until the ultimate debtor pays the funding source. Once it is paid, the funding source releases the Reserve to the client (minus the service fee i.e. the discount)

Factoring companies have differing policies and time lines as to when the Reserve will be released to the client. Some funding sources like to keep a semi-permanent Reserve as partial security for the risk they are incurring in factoring.

Discount
This is the service fee for funding the invoice and is expressed as a discount from the face value of the invoice. The discount varies according to the length of time the invoice has remained outstanding.

Example: 2% 30 days

Obviously, the longer the invoice has remained outstanding, the higher the discount from its face value since the risk of the factor not being paid by the ultimate debtor, increases. That’s why it’s usually a good idea for a business to factor the invoices of its best clients i.e. its fastest paying clients, first. They will receive a lower discount rate on those invoices whilst increasing their cash flow.

© 2006 Sanjeev Aaron Williams & Cashwerks All Rights Reserved

Factoring 101

Where a business has already supplied goods and services to another business (not an individual consumer), it can sell the Invoice to a 3rd party for immediate cash at a discounted value, rather than waiting for its customer to pay up. Factoring is the sale of commercial paper. The 3rd party, having bought the Invoices from the business, now assumes the risk of obtaining payment from the customer.

The company that BUYS the invoices is the Factor (or funding source). The company that SELLS its invoices (also known as Accounts Receivables) is the Client. The company to whom the invoice was addressed, and which remains liable to pay the Client’s invoice, is the DEBTOR.

Having purchased the Receivables, the funding source will initially advance 75% - 90% of the invoice amount up front and will pay the remaining amount – minus a service fee – after the Client’s Debtor pays the full value of the invoice to the funding source. The service fee is expressed as a discount from the face value of the invoice. The discount varies according to the length of time the invoice has remained outstanding.

Factoring is NOT a loan. The Client sells its invoices to the Factor at a discounted amount in return for virtually immediate capital. There is no need for the Client to wait 30, 60, 90, 120 days or longer for its debtors to pay its invoices, or run the risk of declaring them as Bad Debts. In other words, the business that sold the invoices for cash, capitalized on the time value of money.

When a bank extends a line of credit, it means that the company is, or soon will be in debt. In private Factoring, there is no loan and there is no debt. The amount of money available pursuant to a sale of the invoices is based not on the creditworthiness of the company – but of its customers. As the company sells to creditworthy customers, more money is made available and the business can grow exponentially – debt free.

When deciding to factor, the funding source is more interested in the creditworthiness of the Debtor i.e. the payor of the Invoice, because the funding source, in buying the Invoice from the Client, will look to the Debtor for payment.

© 2006 Sanjeev Aaron Williams & Cashwerks All Rights Reserved

Business Cash Flow Cycle 2

OUTGOING CASH

1. Interest on debt servicing – payable periodically. If the company defaults, a full range of legal consequences can follow including removal of Directors, appointment of Receiver/Manager, rescheduling of company debts, restructuring the company, selling collateral, or winding-up the company.

2. Operating Expenses – also known as Overheads. These are usually all expenses that are not directly related to Production.

3. Plant & Equipment – Also the subject of Capital Budgeting, companies have to decide whether to buy or lease such equipment and how long to keep them to claim Depreciation expenses in their Accounts.

4. Manufacturing Expense and Inventory Control – A major cash flow drain, which does not operate at constant levels. High levels of sales, or large variety of products, require high levels of inventory. Also Inventory builds up to reduce the cost of Production, and as a result of uneven sales.

5. Dividends – both private and public companies pay them, sometimes several times a year. There is no legal obligation to declare or pay dividends.

6. Corporate Taxes – may require to be estimated and paid in advance.

© 2006 Sanjeev Aaron Williams & Cashwerks All Rights Reserved

Business Cash Flow Cycle 1

This 2 part breakdown given an overall understanding of how cash moves through a business.

INCOMING CASH

1. Shareowners capital – these are the individuals who really own the company. They provided the initial cash injection when the company was incorporated (or contributed to the business if it was a partnership). In return, they received shares in the company. They can be asked for money periodically, in return for additional shares. Shareholders capital also includes angel investors and venture capitalists. They will however, seek to be repaid on terms and within a certain time frame and should be regarded as private lenders. Whilst they are invested in the company, venture capital shareholders might wish to direct the management of the company.

2. Borrowing – from private lenders or banks. Can either be short term or long term and are the company’s Lines Of Credit. Some can be negotiated beforehand and some companies resort to short term borrowing several times a year. Security or Collateral is required and interest is payable to service the loans.

3. Marketable Securities or Commercial Paper – usually available to the largest and financially strongest companies only. Essentially, the company goes into the Money Market and issues an IOU to obtain large amounts of cash which it will repay on terms at a future date.

4. Accounts Receivables – theoretically the main source of cash into a business. It is generated through sales and timely payment of invoices. In practice, many companies have poor control of their Receivables. This means that their invoices are not properly followed up and their cash flow becomes unpredictable. This impacts the company’s ability to fulfil new orders, grow, invest in marketing, and pay operating expenses such as salary and debt servicing. Poor control of Accounts Receivables can make or break a company.

© 2006 Sanjeev Aaron Williams & Cashwerks All Rights Reserved

Watching Your Cash Flow?

Did you raise enough “seed capital” or “angel investment” or “mezzanine financing” or full blown venture capital?

Exactly what stage of growth is your company at?

How good was your sales forecasting?

How tightly are your expenses being controlled? Are you bleeding the company by drawing prematurely excessive salary?

Reduce inventory to minimal acceptable levels. Consider “just in time” inventory. Otherwise you might be forced to unload unsold inventory at “fire sale” prices.

Inventory financing can be very expensive. A business is effectively penalized by the bank if the inventory offered as collateral remains unsold for too long.

Consider Equipment Leasing strategies instead of buying outright. There may be tax concessions.

Rate your customers on credit worthiness. Decide who will be given credit and for how long.

Revamp you internal Accounts Receivables Management. When the Receivables are factored, the funding source effectively becomes the Receivables Management division of the company. This saves time and expense. It allows the business to focus on sales and marketing which are direct revenue generators.

Bill more frequently – then factor the invoices for faster cash flow. This tactic works best when factoring invoices from your best i.e. most creditworthy clients.

Early payment incentives to your debtors rarely work. Factoring the invoice that you send them does. The cash can be made available within 24 – 48 hours.

© 2006 Sanjeev Aaron Williams & Cashwerks All Rights Reserved

Commercial Invoices & Factoring

Factoring is all about the funding source buying the commercial invoice. In other words, the funding source buys commercial paper.

A company seeking Factoring legally assigns the invoices to the Factor. Depending on the financing needs, the company may assign, from a specific date, all invoices as they arise or, it may simply choose to factor certain invoices over a set time period to get them over a cash flow hump.

© 2006 Sanjeev Aaron Williams & Cashwerks All Rights Reserved

The Commercial Invoice

It's an essential document that evidences the sale of goods or services in a B2B transaction. Yet, it's often taken for granted and not properly scrutinized.

Since Factoring is all about the funding source (the Factor) buying the commercial invoice, herewith is a summary of the important features of an invoice in order for it to qualify for Factoring:

1. Value Of The Invoice - This must be clear and unambiguous. Rarely is there any problem in determining how much the debtor owes to the vendor.

The invoice will usually itemize the quantity of the product of length of time the services were provided. This will be done by a unit price and a total price for the product or service delivery.

2. Payment Terms - The invoice must have the payment terms clearly stated on its face. To be factorable, the invoice must be payable in full and must be in respect of a completed supply of goods or services.

The Factor has to be pretty sure that the debtor will pay within that time frame. Otherwise, factoring fees and discount rates may be affected. The longer the debtor takes to pay, the greater the risk of default - and the greater the risk to the Factor buying that invoice.

3. Verification - The invoice will have the name and contact details of the debtor required to pay it. When it is submitted to the Factor for funding, the Factor will always verify the authenticity of the invoice to confirm that the debtor will no make any set-off, charge-back or adjustments to the invoice amount.

© 2006 Sanjeev Aaron Williams & Cashwerks All Rights Reserved

PO Funding And Factoring

When the manufactured product that is the subject of PO Funding is delivered to the ultimate buyer, the Invoice that is generated will be subjected to Factoring. The PO financing charges will be deducted at this point.

If the sale is COD, the ultimate buyer will pay the PO funder, who will first deduct the PO Funding fees, before remitting the balance to the company.

PO Funding is more expensive than Factoring. Companies are advised to consider it after they have factored, or borrowed on their Receivables and still require additional funding to complete existing Purchase Orders.

Cashwerks www.cashwerks.com is a Commercial Finance Consultancy providing intelligent capital solutions to start ups and mid-sized companies.

© 2006 Sanjeev Aaron Williams & Cashwerks All Rights Reserved

Levels Of Purchase Order Funding

There are 3 levels of PO Funding depending on how closely the company is involved in the manufacture of the goods.

1. The company is not directly involved and has a domestic or foreign supplier manufacture a finished product. The supplier will not start production or will not release the goods until they receive cash payment or, a Letter Of credit is issued to assure payment.

The PO funder will determine that the finished product matches the specifications of the PO and is shipped to the ultimate buyer within the contractually stipulated time.

The good news is that since the finished product will move directly from the producing supplier to the ultimate buyer, the financial condition of the company applying for PO Funding is not as critical. This is the easiest type of PO to be funded.

2. Most of the product is produced by an outside supplier and the partly completed product then moves to the company's facilities for final assembly or packaging. PO Funding may be possible, but the company's financial strength becomes more relevant.

3. The company fully manufactures the product itself. PO Funding will only be provided if the company is financially strong and has a good track record.

Companies that fall into this category already have traditional bank financing, but may have fully drawn down on their credit facility. These companies need further financing due to a sudden increase in new orders.

Cashwerks www.cashwerks.com is a Commercial Finance Consultancy providing intelligent capital solutions to start ups and mid-sized companies.
© 2006 Sanjeev Aaron Williams & Cashwerks All Rights Reserved

Purchase Order Funding 101

A company may have Purchase Orders by which it is to supply GOODS to another business. However, the company does not have enough liquid capital to begin manufacturing the goods. In this case, the company might use PO Funding. Note that PO Funding is only available for a manufactured product. It is NOT available for the supply of services.

PO Funding is short term funding. The company submits the PO and a manufacturing costs breakdown to the funding source. The funder will advance a portion of these costs to the company (or to the company's supplier of the manufactured product).

When the goods are delivered to the company's ultimate buyer, an Invoice is generated. This Invoice will immediately be subjected to Factoring. The funding source of the PO is repaid the advance plus his fee by the funding source who factors the Invoice.

PO Funding is regarded as high risk since the goods have not been manufactured - or are only partially complete. Factoring is always involved in PO Funding. The entire transaction of PO Funding and Factoring can be done by a single funding source, or can be split between a PO funder and a Factor.

© 2006 Sanjeev Aaron Williams & Cashwerks All Rights Reserved

10 Reasons Why Businesses Fail

Timeless advice. The source of this posting is acknowledged below.

1. Undercapitalization
Too many SMEs underestimate how much money is needed at start-up and during a potentially lengthy transition as the business attempts to make it to commercial viability. By starting out undercapitalized, a business may never have enough to catch up.

2. Poor Cash Flow
Intermittent or poorly managed cash flow fails to meet recurring and capital expenses. The business develops a “cash flow burn rate that is not met by income.

3. Lousy Planning
Lack of a comprehensive business plan that covers all the bases.

4. No Competitive Edge
Lack of clearly identifiable niche and a failure to identify at least 1 element that sets the business apart from its competitors. Becomes a facsimile of ever other business in that field.

5. Lousy Marketing
Poor and non-unique marketing

6. Delayed Flexibility
The ability to correct on-the-fly is crucial to SME’s success.

7. Incomplete Customer Service
Not just the obvious, but the stuff that goes beyond the ordinary.

8. Lack Of Specialist Help
Refusing to talk to Accountants, Lawyers, Tax Advisors who specialize in SMEs.

9. Disconnect Between Founders And Staff
Failure to share the vision, failure of staff to buy into it, inadequate staff training, lousy staff compensation, self-indulgent executives.

10. Poor Scaleability And Uncontrolled Growth
Many SMEs that succeed too early, fail early too. Further, SMEs may have their highest sales volume just before they fail. Production systems must keep up with demand and there must be sufficient cash for expansion. Expansion must be tracked and controlled.

The above posting is taken from an article entitled “10 Reasons Why Businesses Fail” published in the American Cash Flow Journal, December 2002.

www.cashwerks.com

© 2006 Sanjeev Aaron Williams & Cashwerks All Rights Reserved

Cash Flow And The Quick Fix

Often, companies approached Cashwerks looking for an instant solution to their cash flow problems. The Directors proclaimed their own solution and demanded the Quick Fix. They were reluctant to talk about the company’s business, its future growth, the effectiveness of the funding or even the cost of the funding.

Fixated on their solution to a perceived problem, they turned defensive when told the Due Diligence requirements of the funding source.

Predictably, these deals failed and the encounter was somewhat childish. There was no solution to a multi-layered problem and if there was, it was probably wrong or deficient.

Months later, Cashwerks would be contacted again by the same company. This time, there was panic in the Directors’ voices. The company was going under, the banks had turned hostile. The company was now ready to listen.

After the deal had gone through, the Directors quietly admitted they should have listened and acted months earlier.

© 2006 Sanjeev Aaron Williams & Cashwerks All Rights Reserved

Sanjeev Aaron Williams

Sanjeev Aaron Williams is a Lawyer. He’s also a Commercial Finance Consultant affiliated with the American Cash Flow Association. Sanjeev has an extensive network of reputable private funding sources in North America. His corporate website is at www.cashwerks.com

Cashwerks niche is Factoring new and mid-sized companies in North America. So why this blog?

First, the various issues in Factoring were better dealt with in a blog rather than swamping the Cashwerks website.

Second, a Factoring deal sometimes involved Commercial Finance issues which the client wanted to discuss with Sanjeev and his funding sources.

Third, the client needed specific Commercial Financing and wanted Sanjeev's funding sources to handle it.

The blog gives start-ups and mid-sized businesses a context in which to consider financing options. These Commercial Finance solutions can be used jointly or independently.

The blog covers the following Commercial Finance topics:

Accounts Receivables Funding (Factoring)
Purchase Order Funding
Letter Of Credit Funding
Asset Based Lending
Equipment Leasing
Venture Capital

Comments can be made to Sanjeev Aaron Williams via the Cashwerks website www.cashwerks.com or directly on the blog. Copyright to this blog vests in Sanjeev Aaron Williams and Cashwerks.

Dated the October Full Moon 2006

© 2006 Sanjeev Aaron Williams & Cashwerks All Rights Reserved