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