Factoring & Bank Financing

The author has frequently said that factoring can be used in conjunction with traditional bank financing. What does this actually mean?

A business in the early stages of growth may not qualify for the best terms for bank loans since it doesn’t have a history. If a business line of credit or a loan is forthcoming, often it will be secured on the Receivables – in other words, every Invoice generated by the business acts as security for the loan. The problem with that, is those Invoices represent potential cash whose value is presently frozen – at least until they are finally paid by the debtor 30 plus days down the line.

For a start-up or early stage business, tying up the invoices to the bank and hoping the debtors will pay fast, is not the best strategy. It leaves the business without critical cash flow control and can hamper growth.

Since factoring requires creditworthy debtors more than it requires the operating history of the business, then (subject to good profit margins), factoring may be a better alternative.

Once cash flow has been stabilized and is predictable through factoring, the business will be in a better position to negotiate a bank loan – with the added advantage that its invoices have already been assigned to the factor and therefore out of reach of the bank.

Servicing the loan becomes that much easier since cash flow from factoring can already be calculated.

Remember also that banks tend to be conservative. Factoring companies are more flexible and forward looking in their assessment of the business prospects.

© 2007 Sanjeev Aaron Williams & Cashwerks All Rights Reserved

Stating The Obvious

It’s mind boggling to discover just how much difficulty business owners have in grasping the concept of a “final sale” in the context of factoring.

Start with this: For an invoice to be factored there MUST be a final sale B2B.

In other words, there has to be a completed product or service that has been delivered to and accepted by the customer – and on which, payment is now due.

• Forget about factoring partial deliveries where payment is not due until final delivery.

• Forget about factoring invoices on returned items.

• Forget about factoring invoices for sale by consignment i.e. the debtor does not have to pay until it has re-sold the product.

The Reader is also referred to previous posts under the label, “Commercial Invoice”.

© 2007 Sanjeev Aaron Williams & Cashwerks All Rights Reserved

The Hard Truth

Frequently, companies moan that the cost of factoring is too high. Fine. In some situations, it is and would not be the best option. SAW has told companies to forget factoring and try something else.

A personal rule of thumb:

• A business with gross profit margins of less than 15%: forget it

• A business with gross profit margins of 15% - 20%: possible

• A business with gross profit margins of 20% or more: ideal

© 2007 Sanjeev Aaron Williams & Cashwerks All Rights Reserved

The Personal Guarantee

Many company directors choke when they look at the factoring documentation package and see the requirement for them to sign a Personal Guarantee. Some walk away from the deal altogether, claiming they’ve made enough disclosure. Others say the Personal Guarantee reeks of traditional bank financing.

Let’s make one thing very clear. Corporations, by themselves, don’t commit fraud. It’s the people behind them. The Personal Guarantee is the factor’s safeguard against fraud – and not, as is commonly assumed, an alternative means of recovering payment by going after an individual.

Factors carry credit insurance in respect of funds that they advance on a non-recourse basis. Many factors advance funds pursuant to a Line of Credit that they have with their banks. As a condition of the credit insurance and the bank Line Of Credit, factors are required to obtain a Personal Guarantee from the directors of their customers.

As and when the factor has funded an invoice for which it has not been paid by the ultimate debtor, it is far cheaper to simply off-set the amount against future advances, rather than resorting to litigation via the Personal Guarantee.

© 2007 Sanjeev Aaron Williams & Cashwerks All Rights Reserved