Telling The Customer

For starters, Factoring is not new. It’s been around for several hundred years and that in itself is a surprise – particularly to small and mid-sized companies who habitually look for traditional financing via a bank. Large and very well known publicly listed companies factor all the time.

The business has decided to rationalize its cash flow in order to guarantee future expansion. The fact that you are not using a traditional bank, but private financing, shows that the company is financially attractive. It therefore has a range of financing options.

The customer’s payment terms will not change.

The customer will still have the routine contact with the business and its personnel. Nothing will change there.

All the business invoices to the customer will come via the Factoring company, with a written instruction that the customer is to make full payment on that invoice direct to the Factoring company.

The Factoring company is not a collection agency, but they will be providing real time online status of unpaid and paid invoices to the business. This will allow the business to objectively monitor its cash flow from all or any of its customers.

© 2007 Sanjeev Aaron Williams & Cashwerks All Rights Reserved

14 Reasons To Factor

1. Leverage your customers credit.

2. Factoring is faster than a bank loan. The documentation is straightforward

3. Factoring company acts as your Receivables Management company, providing real time status of your outstanding invoices. They will be in charge of collections.

4. The Business can concentrate on Sales and Marketing instead of chasing up unpaid invoices.

5. Factoring companies will do credit checks on your customers and warn you of potentially high risk customers.

6. Faster incoming cash flow to meet overheads plus capital investments either by way of outright purchase or equipment leasing. If leasing, then guaranteed cash flow will help the business calculate lease payments.

7. The business can choose which invoices to factor, how much they want in factored funds and for how long. Alternatively they can factor all invoices indefinitely.

8. Increased cash flow means the business can take advantage of early payment discounts from its suppliers.

9. The Business can stop offering early payment discounts to its customers. In practice, customers who have more time to pay, buy more goods and services more frequently.

10. Faster incoming cash flow means a business can build or repair its credit and service debt more confidently.

11. Accounts Receivables become an immediate liquid asset, instead of a contingent asset on the Balance Sheet.

12. Factoring reduces the amount of Bad Debt which appears on the Balance Sheet.

13. Since Factoring is the sale of invoices for cash, no new debt is incurred.

14. No need for the business to surrender equity.

© 2007 Sanjeev Aaron Williams & Cashwerks All Rights Reserved

Factoring Question 11

If the Factoring company is buying the invoices, does our business actually get to bill the customer?

The business prepares its invoice to the customer in the normal way, showing the delivery of completed goods or services. The original invoice is sent to the Factoring company, who will bill the customer, pointing out that payment is to be made to the Factoring company.

The Factoring company would also verify the invoice with the customer and then make the advance to you.

© 2007 Sanjeev Aaron Williams & Cashwerks All Rights Reserved

Factoring Question 10

What is the Factoring procedure?

This is explained on the Cashwerks web site.

© 2007 Sanjeev Aaron Williams & Cashwerks All Rights Reserved

Factoring Question 9

Where the bank has security over the invoices, how does Subordination work if we need Factoring?

In practice, the Factoring company, the business and the bank will negotiate. The objective is to allow the Factoring company to have priority over at least a portion of the invoice values. This is done by way of a Creditors Agreement.

For example, if there are $100,000 worth of invoices, the Agreement might allow the Factoring company to have priority on the first $50,000 worth of generated invoices, with the Bank secured over the remaining $50,000 (with or without additional collateral put up by the business).

In that case, now that the Factoring company has obtained security over the first $50,000 worth of invoices, they could factor the company up to that amount.

© 2007 Sanjeev Aaron Williams & Cashwerks All Rights Reserved

Factoring Question 8

Is it necessary for our customers to know that our invoice to them have been factored? Does it affect our business credibility with them?

Yes it is necessary for your customers to know that your invoices to them have been factored. This is because there has been a legal assignment of them in favour of the Factoring company. Your customers are legally bound to now pay the full face value of the invoice to the factoring company. That’s why they require notice.

Further, Factoring companies have a duty to notify your customers and a duty to verify that the invoices relating to that customer are genuine.

Factoring companies are very sensitive when it comes to dealing with your business customers. This is because they have taken over the management of your Receivables. This involves tracking how quickly they are paid by your customers and very often allowing you to see it online in real time.

Factoring companies are fully aware of the relationship between a business and its customers. It’s not in their interests to sabotage it. Many Factoring companies will discuss this with you and customize their approach to your customers.

Don’t forget: the fact that a third party is funding your Receivables, is an important signal to your customers that your business is regarded as being in a good financial position and poised for future growth.

© 2007 Sanjeev Aaron Williams & Cashwerks All Rights Reserved

Factoring Question 7

If the company has an existing bank loan or is drawing on a bank line of credit, can its invoices still be factored?

That depends on the cooperation of the bank. Frequently a start-up, or an established growing company requires capital and will approach a bank (after getting initial capital from family or friends). Collateral for the bank loan may be by way of home equity, stocks or using a third party as Guarantor.

However, the bank usually assigns to itself the tangible assets of the business, as additional security. This covers the invoices, which are technically, commercial paper and therefore a business asset. The document by which the bank receives security over the invoices, is known as the UCC-1 Financing Statement.

If in future the business wishes to factor its invoices, it must disclose the UCC1-Financing Statement to the Factoring company. Since the bank now owns the Receivables, the Factoring company must obtain the bank’s approval to subordinate those Receivables, and thereby relinquish ownership.

Only when that is done and the Receivables assigned to the Factor, will factored funds be available.

Banks are generally open to subordinating, but it must be dealt with on a case by case basis. If the bank has concerns, then either factoring will not go ahead, or the business will first have to pay off the loan or make a significant payment towards its reduction.

© 2007 Sanjeev Aaron Williams & Cashwerks All Rights Reserved

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