The First 3 Months Of The Year

It may come as a surprise to realize that January, February and March are difficult for businesses, even during good times. Why?

During these months, companies analyze and plan their objectives for the year. It might include expansion of product lines, production facilities, more employees, upgrading the marketing.

The company needs to project where the additional funding will be coming from, while still having cash on hand to pay expenses incurred at the end of the proceeding year. It is important to note that while the cost of expansion will be recovered at some point in the future, the costs of expansion are payable now.

It’s at this time of year that a company should be considering factoring. The cost of factoring will be offset by the additional revenue generated by their expansion plan. For example, if a business concludes that an expansion of its sales and marketing staff will generate more revenue in the coming 6 months, they could factor the revenue during those 6 months in order to have the cash resources to grow beyond that period.

© 2007 Sanjeev Aaron Williams & Cashwerks All Rights Reserved

Factoring And Insolvency 2

The business is then required to obtain and unsecured loan. At first glance, it sounds paradoxical since the business is likely insolvent and lenders require collateral. Banks might not step up to the plate and the business will initially look to individuals or angel investors.

In reality, assuming that the business still has customers, the only tangible security it can offer are its new sales, evidenced by the invoices (which are technically, commercial paper).

For the purposes of Bankruptcy, factoring is not regarded as being in the ordinary course of business and the business must obtain the Court’s permission to factor its receivables. The Court will hear the factoring proposal and any objections from the creditors.

If the Order is made, the business will be allowed to factor the receivables which came into existence on or after the date of the filing of the Bankruptcy Petition. The factoring may be for a specific period of time (which can be extended by further order) and may require the factor to pay a portion of the advance into a designated account in favour of the creditors.

It is important to note that the Court’s Order is as good as a UCC filing.

Note: this posting is in general terms only and is not to be taken as containing specific or implied legal advice. A business must consult its lawyers and accountants where Chapter 11 is contemplated.

© 2007 Sanjeev Aaron Williams & Cashwerks All Rights Reserved

Factoring And Insolvency 1

There is no doubt that factoring enhances cash flow for a business operating as a going concern. But what about a business that is unable to meet its current debt obligations and is facing insolvency?

In the US, a business may seek temporary protection from its creditors by filing a Chapter 11 Bankruptcy Petition in the Federal Bankruptcy Court. The effect of the Petition is to create an automatic stay that suspends the ability of any creditor, secured, or unsecured, to obtain payment from the company or to enforce the security.

Further, the Petition generally prevents the company’s future assets from being appropriated by creditors – notwithstanding any language to the contrary in any security agreement.

That means that a creditor who, in its agreement with the business, used typical language to secure “all the accounts receivables of the business whether currently existing, or hereafter arising, no longer holds an interest in those receivables which come into existence after the filing date of the Bankruptcy Petition.

Effectively, the business can make a fresh start with those receivables and negotiate with the creditors to formulate a Cash Collateral Order (which allows the business to use existing cash to meet at least a portion of ongoing obligations) and the Plan of Reorganization.

However, before Factoring can be implemented to assist the business, a few more steps are required. These are set out in the next post, entitled, Factoring & Insolvency 2.

© 2007 Sanjeev Aaron Williams & Cashwerks All Rights Reserved

Factoring Flexibility 6

Invoice Batching

This is most commonly done where there are a series of invoices for small amounts. The invoices would be batched and treated as a single invoice. Once enough invoices from that batch are collected to cover the advance and the factoring fees, the batch is deemed “closed”. Thereafter every invoice of that batch which is collected from the debtor, is paid over in full to the client.

The effect is that the client is charged a lower discount fee, normally reserved for larger invoices, instead of being charged a higher discount fee normally charged on small invoices.

© 2007 Sanjeev Aaron Williams & Cashwerks All Rights Reserved

Factoring Flexibility 5

Invoice Splitting

In order to save the client some fees, the factoring company might split an invoice i.e. notionally splitting it into sub-invoices. This is usually done where the debtor makes partial payment on the invoice over a period of time, instead of paying it all off at once.

The effect of splitting the invoice is that higher fees are charged only on the later partial portions, instead of the full face value of the invoice.

© 2007 Sanjeev Aaron Williams & Cashwerks All Rights Reserved

Factoring Flexibility 4

Partial Funding Of Invoice

Since factoring is all about generating predictable cash flow for the client, it sometimes happens that the client wants to control the amount of cash flowing in. For example, a client may have factored a large invoice, but the present cash flow needs of the business are sufficient.

In order to save the client from paying unnecessary factoring fees on the full amount of the invoice, a factoring company may agree to partially fund that invoice for an amount set by the client. Factoring fees will be paid on the partial amount only.

Once the full amount of the invoice is paid by the debtor, the factoring company will keep the advance and its fees, calculated on the partial amount, and remit the unfactored amount to the client.

© 2007 Sanjeev Aaron Williams & Cashwerks All Rights Reserved

Factoring Flexibility 3

Discounts On Fees

If a debtor takes a long time to pay on an invoice, the factoring company might give a discount on the fees to the client, for the sake of the business relationship. There might not be a contractual obligation to do so, but it could be done.

© 2007 Sanjeev Aaron Williams & Cashwerks All Rights Reserved

Factoring Flexibility 2

Buyback Or Replacement Of Invoices

The cost of Factoring is paid by factoring fees. These are determined by how long an invoice remains unpaid. Factoring companies will allow the client to buy back an ageing invoice; or substitute it with a fresh invoice. This stops further fees on the previous invoice or prevents the old invoice from exceeding the ageing limit imposed by the factoring company.

Buyback - the client pays cash to cover the advance and the factoring fees on that invoice;

Replacement – the client replaces the ageing invoice with a fresh invoice of a suitable amount so that the advance on the fresh invoice covers both the advance and factoring fees on the old invoice.

© 2007 Sanjeev Aaron Williams & Cashwerks All Rights Reserved

Factoring Flexibility 1

Fast Payment Of Reserve

From the factoring company’s view, each invoice that is factored, is an individual transaction. Therefore, once the full face value of the invoice has been recovered from the debtor, the Reserve is theoretically payable to the client immediately.

Some factoring companies will pay the Reserve to the client the same day. For smaller amounts, daily payments of the Reserve might not be administratively practical. In such cases a factoring company might pay the Reserve amount to a client weekly.

That’s not necessarily a bad thing. It could be agreed beforehand that if Reserve payments are made weekly, then they must be paid before payroll is due,

© 2007 Sanjeev Aaron Williams & Cashwerks All Rights Reserved

Factoring Question 13

Why is it necessary for the business to sign the factoring documentation, only to have it backed up by a Director’s Personal Guarantee?

Corporations by themselves don’t commit fraud. It’s the people behind them.

© 2007 Sanjeev Aaron Williams & Cashwerks All Rights Reserved

Factoring Question 12

Why is it necessary to pledge all the business receivables as collateral on the UCC-1 if the business is not factoring all the receivables?

The term “accounts receivables” may sound like a plural, but technically, it is one class of collateral and cannot be divided.

Further, as far as the factoring company is concerned, there is no collateral value in having recourse only to the non-performing receivables.

© 2007 Sanjeev Aaron Williams & Cashwerks All Rights Reserved

The Cost Of Extending Credit

When a business extends credit to its customer, the business effectively becomes their banker. This is because the business has lent money to the customer, free of interest for 30 days or more. In the meantime, the business has lost the use of that cash, while hoping that it will be paid.

Extending credit on a regular basis affects a business in 3 ways

1. The business loses interest income that it could have earned – even in a low interest savings account.

2. The business may not have enough liquid funds to pay for volume discounts or early payment discounts from its suppliers.

3. The business may lack the working capital to begin the next job or project and thereby risk losing potentially profitable business from creditworthy customers.

© 2007 Sanjeev Aaron Williams & Cashwerks All Rights Reserved