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

Factoring & Inventory Financing

For the avoidance of doubt, they are completely different.

Factoring requires the completed delivery of goods or services, for which an invoice has been issued, awaiting payment. The invoice is sold at a discount to a Factoring company in return for an initial cash advance.

Since Factoring is the sale of an invoice, it is not a loan. It allows a company to grow debt-free.

Inventory Financing is a line of credit secured by physical inventory. It makes the cash tied up in your Inventory available to you. It is a LOAN and therefore repayable – It is a Lender / Borrower arrangement.

It is usually available to businesses with good credit and sales history. By contrast, Factoring focuses on the credit worthiness of the debtors of the business i.e. the customers who are responsible to pay the invoice.

When Is Inventory Financing Available?

1. When you have a warehouse of goods ready to ship, but find yourself short of cash to buy supplies for your next production cycle;

2. When you have to maintain high levels of inventory to conduct ongoing business that keeps too much of your cash tied up.

3. When you have good turnover in your inventory, but are short on cash flow and you have to keep replenishing your stock.


When Is Inventory Financing Not Advisable?

When you have a storeroom full of out of date or hard to sell merchandise. It will add interest charges and will make a bad situation worse.


Potential Problems With Inventory Financing

1. High interest rates or other fees.

2. You may have to pay off the Line of Credit every 12 months – regardless of the state of your Inventory.

3. If sales slow down, you may have to unload your Inventory at a loss, undermining your ability to stay current on your line of credit.

4. The interest on the loan may sap your ability to keep production or shipment on schedule.

© 2007 Sanjeev Aaron Williams & Cashwerks All Rights Reserved

9 More Reasons To Factor

1. Meet Payroll and Payroll taxes.

2. Pay off outstanding debt.

3. Service existing debt promptly and improve the business credit rating.

4. Fund new Marketing strategies.

5. Fund new E-commerce strategies.

6. Increase available cash on the Balance Sheet while reducing the amount of Accounts Receivables.

7. Reduce or eliminate the need for outside investment in the company

8. Makes the company more attractive to outside investment because of guaranteed cash flow.

9. Factoring operates as a stand-along product, or, it can work alongside traditional bank finance or venture capital or loans from Small Business Organizations.

© 2007 Sanjeev Aaron Williams & Cashwerks All Rights Reserved

Factoring And Outsourcing

Much has been written about Outsourcing and the apparently detrimental effect it is having on the workforce. Regrettably, we are being conditioned to automatically assume that Outsourcing means having your skills exported halfway around the world where your job can be done for a fraction of your salary.

In Factoring, when the invoices are sold, the Factor becomes the company’s Receivables Management arm. If a company always has its eye on the bottom line, the hard truth is that chasing up on unpaid invoices is neither efficient in terms of cost or time.

The reality is that the company has to focus on Sales, Marketing and Production.

Therefore, Factoring effectively allows a company to outsource non-productive work, without attrition or loss of critical people skills and guaranteeing themselves a steady cash flow, without additional debt.

© 2007 Sanjeev Aaron Williams & Cashwerks All Rights Reserved

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