A guide to improving cash flow in a tight credit market.
Tightened standards on commercial loans and lines of credit in recent years have made everyone a little wary, especially business owners. As the credit markets continue to dry up and business financing becomes harder to obtain, customers are requesting extended payment terms on invoices, or in extreme cases, ignoring payment terms and paying on their own schedule. This can put a business owner in a tight situation when operational expenses need to be paid in a timely manner. Employees need to be paid, rent needs to be paid, supplies need to be purchased, and the list goes on. If a business wants to expand, owners face even more difficulty. This is where factoring, a solution to improve cash flow and support a growing business, comes in.
- What is factoring?
Simply stated, factoring is the sale of a company’s receivables. It occurs when a business-to-business company sells its invoices for a small fee to an accounts receivable funding company, also known as a factor, and receives immediate payment. Factoring is also known as accounts receivable funding, receivables factoring and debtor funding.
By nature, in general business activity, the payment of revenues and expenses do not usually occur at the same time. Factoring helps increase cash flow by decreasing (or in some cases, eliminating) the wait time for an invoice to be paid. With factoring, as services are performed or a product is sold, a company can sell its invoices and receive immediate payment for these transactions. The funds inject capital into the business and allow it to grow by increasing its ability to conduct and take on business, and therefore increasing its revenue too.
Typically, funds made available through factoring are used to cover operational expenses such as payroll, rent and to purchase inventory. Many business owners that work with a factor claim that factoring not only helps keep their business running and growing, but also gives them peace of mind by allowing them to collect their profits immediately.
- Who are the parties involved in factoring?
There are three parties involved in factoring:
Factor – The factor is the company that funds invoices for as much as 99 percent of their face value. The factoring fee is determined by the amount of total invoices to be funded, plus the credit worthiness of the client’s customers. The American Factoring Association estimates there are currently up to 350 factoring companies in the U.S. and a market of approximately $180 billion in revenues being factored.
Client/Seller – The client or seller is the business-to-business company that sells its invoices to be factored. After entering into an agreement with the factor, the client no longer needs to be burdened with managing their accounts receivable. The client simply submits invoices to the factor, receives upfront funding – plus backend payment – and continues to conduct business as usual.
Debtor/Customer – The debtor is the company to which the invoices are billed. When a client begins factoring, the debtor is notified of the sale of the receivable, and the factor sends the invoice to the debtor. Most factoring companies work to make the transition from traditional billing to working with a factor as seamless as possible for both the client and debtor.
- Factoring process?
The factoring process begins with a simple application that can oftentimes be completed quickly online. Once the client’s application is approved, the client presents an invoice for a product or service they have already or will soon deliver, to their customer. The factor then buys the invoice from the client. The purchase amount, often considered an advance, is a large percentage of the invoice value that is paid to the client upon submission of the invoice to the factor. The advance can be paid in as little as four hours, allowing the client to increase cash flow immediately.
The factor then collects on the invoice from the debtor and holds the remaining total invoice amount, less the advance, until payment by the debtor is complete. Finally, the factor submits the reserve to the client, minus a predetermined fee, which the factor retains. The fees charged by factors can vary widely, typically in the range of 1 percent to 10 percent, depending on how quickly the invoice is paid.
There are two types of factoring:
Recourse Factoring – With a recourse factoring agreement, the client/seller remains responsible for the invoices if the debtor does not pay the factor. Typically required to be paid within 90 days, the risk associated with the invoice remains with the seller. If a debtor defaults on an invoice, the factor will collect the advance back from the client.
Non-Recourse Factoring – With non-recourse factoring, the factor assumes the credit risk associated with the purchased invoices. Because this type of factoring is riskier for the factor, fees are traditionally higher than with recourse factoring. Generally fewer factors are offering the option of non-recourse factoring.
- What is factoring used for?
Business-to-business companies of all sizes and types utilize the benefits of factoring to:
Business-to-business companies of all sizes and types utilize the benefits of factoring to:
- Stay out of debt and end reliance on bank loans and lines of credit
- Improve cash flow to grow the company, keep current with accounts payable, including taking advantage of vendor discounts, and cover operational expenses, even when customers are requesting extended payment terms
- Cut credit exposure by not overextending finances
- Enhance income statement and balance sheet
- Eliminate all future bad debt
- Eliminate the need for time and resources spent on collections
Although many companies turn to factoring when faced with the situations above, many others see factoring as a viable alternative to borrowing money and as a smart general business decision to stay out of debt.
For example, an Orlando-based medical courier service recently turned to AmeriFactors, a national factoring company, because it had run out of funding options with its bank. Due to the nature of its business, the courier company didn’t have assets to leverage, but it did have the opportunity to take on a new client. In order to accept the new client, the company’s owner needed to know that he could pay his couriers weekly, even though the new customer could take up to 60 days to pay its invoices. The owner learned about factoring from a friend and contacted AmeriFactors. He was approved within days, and after working with AmeriFactors for just three months, has been able to take on three additional contracts and increase gross sales by 8 percent.
- Is factoring right for my business?
Most businesses that invoice other businesses on a net 30, 60 or 90 day invoice schedule will benefit from factoring. While many industries are able to factor, the factoring process has proven to work especially well within a variety of business-to- business industries including:
- Exporters/Importers
- Manufacturers/Wholesalers/Retailers/Distributors/Warehousing
- Advertising/Marketing/Consulting/Printing/Publishing
- Agriculture/Food Service
- Apparel/Garment/Textile/Fabrication
- Property Management/Property Maintenance/Security/HVAC, Oil & Gas Services
- Contractors/Building Services
- Staffing/Medical Staffing
- Recruiting/Training/Education
- IT/Technology
- Energy/Utilities/Engineering/Environmental
- Transportation/Freight/Logistics/Courier/Auto Services
- Office Supply/Equipment Supply/Equipment Service
In short, any company that typically issues large invoices to another business, which takes a month or longer to ultimately make payment, is an ideal candidate for factoring.
- Why Factoring is an Alternative to a Small Business Loan or Line of Credit?
It’s not a loan. You don’t owe the money back.
Factoring is not a loan, so a business doesn’t owe the money to anyone. It is the purchase of a financial asset. This being said, when a client participates in factoring, they do not have to worry about an outstanding balance.
Emphasis is placed on your customer’s financial history.
With factoring, the emphasis is placed on the debtor’s credit and ability to pay its invoices, verses the client’s credit or ability to pay. While bank loans place a value on the organization’s credit worthiness and assets such as real estate, capital, inventory and accounts receivables, factoring is focused more on the debtor.
With factoring, the emphasis is placed on the debtor’s credit and ability to pay its invoices, verses the client’s credit or ability to pay. While bank loans place a value on the organization’s credit worthiness and assets such as real estate, capital, inventory and accounts receivables, factoring is focused more on the debtor.
It’s simple and fast.
Because factoring is based on the debtor’s history, it doesn’t require complicated and time consuming paperwork on the client’s part. In fact, many businesses can be approved on the same day they apply and can receive cash in as little as 24 hours.
The growth possibilities are endless.
Because factoring is based on the client’s customers’ ability to pay, companies can continue to take multiple customer orders without the risk of overextending their finances. With a small business loan or line of credit, an organization may be forced to delay taking on new business to apply for an increase. Factoring works in parallel with your business, and as your business grows, so does the client’s access to those funds.
- About AmeriFactors
For more than 22 years, AmeriFactors has been a proponent of small to medium-sized businesses, supporting their cash flow needs and growth through accounts receivable funding. Also known as factoring, AmeriFactors buys invoices, on a non-recourse basis, from business-to-business companies to provide them with the cash they need to operate their business. Guided by Founder & President Kevin Gowen, AmeriFactors was built on the belief that all businesses, from small to large, regardless of industry, should have the right to grow and prosper without relying on banks and credit cards. Therefore, AmeriFactors works to provide the most expedient, reliable and fee competitive factoring services to clients nationwide to help them run their businesses and realize their dreams. For more information on factoring, visit AmeriFactors.com or call 800.884.FUND.
