Art of Factoring

Invoice factoring companies and lenders in general are risk adverse, meaning the factoring company is always considering how a deal can go bad. Since the funding is based on the ability to collect on an invoice, anything that can go wrong is taken into consideration. For this reason a very thorough and deliberate process is in place to mitigate the potential problems that may arise when an invoice has been factored. While it may seem overly conservative or cautionary at times, the factoring company has time and experience on their side to show that accounts receivable financing, done right, is a very safe way to leverage an asset.

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1. Bookkeeping – install accounting software and use it regularly to track the company accounts receivables.
2. Customer Credit – Show you have a program in place to check the credit of customers who you offer terms for payment on sales.
3. Line Amount – Know the amount of new invoices you prepare monthly and how much you are considering factoring.
4. Business Model– Do you invoice for work completed and get acceptance from the customer?
5. Assets Available - Are there any pre-existing loans that use accounts receivable as collateral?
6. Team – Who is going to be responsible and the persons backing them up?
7. Loan Package – Pull all the information together in a folder ready to send to the factoring company, including factoring application, current Balance Sheet, Income Statement, Payables & Receivables aging reports, history of the company, new contracts being awarded, other assets owned by the company, copies of formation documents, and any information pertaining to bad news that might be revealed through the factoring due diligence process.

When a business is considering invoice factoring as a way to increase capital availability, they must be certain that their accounts receivables are clear to offer as collateral. If the business has used its assets to secure any credit from an individual or credit facility, chances are a UCC-1 financing statement was filed on that collateral. The Uniform Commercial Code (UCC) has a long history based on laws passed to modernize and codify the various individual state laws that apply to commercial transactions. You can read much more about the UCC here and here.

Where this specifically pertains to a factoring company who is interested in collateralizing their clients invoices, is the factor must have a secured position on those receivables. In lay terms, the UCC provides two functions with regard to lending capital. The first being the gate keeper, allowing any lender to know immediately if the collateral they are lending against has already been spoken for. And the second is to determine who those secured lenders are in the cases of liquidation of assets.

Invoice factoring is a different form of financing than purchase order financing. The dissimilarity is based on the work being done and the risks involved. Accounts receivable factoring cannot be utilized until the work is completed and accepted by the customer. Whether providing a service or selling a product, the customer has to be satisfied with the work before the invoice can be financed. The risk for repayment is based on the creditworthiness of the account debtor (customer), therefore it costs less than P.O. financing.

Purchase Order financing is for companies that have a proven track record for performing on a contract. This is when a company has been around for a while and shows that it can complete the order as a regular course of business. Once the purchase order has been verified, credit will be extended to help fulfill the order. This usually is in the form of a Letter of Credit issued to the supplier of goods that have been ordered to fulfill the P.O. Once the supplier ships the order, the LOC must be paid off. Therefore many companies use invoice factoring in conjunction with purchase order financing. P.O. financing is based on the performance, so it is riskier and more expensive.

In order to use accounts receivable financing for growing a business, the work being performed must be completed and accepted. Submitting an invoice to be funded prior to the work being done is called “pre-billing.” A good example of this are advertising transactions. A magazine publisher has collected a group of customers who plan to advertise in an upcoming issue. This means the ads have not run and the customer has not received the full service which gives them grounds to not pay the invoice.

The crux of pre-billing and why factoring companies are reluctant to fund those invoices is the ability for the customer to not pay the invoice and win in court on a collection action. Without proof that the service has been fully rendered, the court will be reluctant to side with the collector. A factoring company has to know that their collection rights are solid in order to mitigate the risk involved in making an advance on invoices.

Before getting started with invoice factoring, does the business have an existing loan with a bank? An important calculation to be examined when contemplating accounts receivable factoring is how to pay off a previous loan. Many times businesses have a line of credit with a bank which they have outgrown. Seeking invoice factoring may be a suitable replacement, but the UCC-1 needs to be free and clear. The question becomes, can the business withstand the loss of income due to paying off the existing loan? Because the accounts receivable has been used as collateral for the old loan, it must be paid off in order for the factoring company to begin making advances on the invoices. That payoff amount will come out of the operating budget. Most companies have spent that slowly over a long period of time. Having to pay it back all at once can be painful, and makes the decision to use invoice factoring an important consideration.

When an invoice factoring company purchases the proceeds of an invoice and makes an advance, it is required by statute to inform the account debtor (customer) the assignment has been made. The factoring client has assigned the proceeds (payment) of an invoice to the factoring company. With proper notification, failure by the account debtor to pay the factor directly results in a “payment over notice claim.” Whereby the factoring company will take the account debtor to court and force them to pay twice on the same invoice – once wrongly to the client and the second time correctly to the assignor. The client’s customer could loose in court and will have to pay twice. Obviously this sours the relationship with the account receivable factoring company and its client. That is why it is imperative the payments go directly to the factoring company.

Many factoring companies handle the notification differently. The proper method is for the account debtor to sign a notification letter that advises them of the assignment. Any receivable factoring company that does not actively require customers to acknowledge an assignment of claims is working loosely with the rules and is bound to be on the short end of a failed transaction. So, on the one hand it sounds enticing that a factoring company does not require a customer to sign a form acknowledging that an invoice has been assigned, on the other hand, one day that factor will be in its own cash flow trouble.

Accounts receivable factoring companies often times assist personnel staffing firms in growing their business. The overwhelming labor quotient can become a real headache from lack of cash flow, as bigger contracts are signed and more employees are placed. A great benefit is realized by factoring those invoices to meet weekly payroll. It’s an acceptable method to get through a growth period. Typically, well run staffing firms have excellent profit margins so the nominal financing charges are not going to be a burden on the bottom line. This is especially true when you consider how many additional employees can be placed knowing payroll is available every time a new invoice is produced.

Because it is so simple to use, easy to set up, and a ready access to capital, accounts receivable financing is a trusted tool of the temporary staffing industry. Learn more about how you can benefit here.

In the world of invoice factoring, careful distinction should be made when describing the different participants. This is how factoring companies talk about different parties to the factoring transaction. When a prospect comes seeking accounts receivable financing, they are considered the “client.” Throughout the factoring relationship the borrower will be known as the “client.”

Each factoring client has “customers” who they provide services or products to and then invoice. Factors make advances on invoices to the client’s customers. Customers are also known as “account debtors.” As always the credit worthiness of the account debtor will be the condition upon which advances are considered.

A receivable factoring client receives advances on customer invoices.

Much is being made of the current financial state of affairs in our country. As it pertains to invoice financing, factoring companies are affected only indirectly to the turmoil in today’s marketplace. For the most part, clients coming for factoring will not see any obvious increases in the cost of accounts receivable financing. The rates are holding steady and there is sufficient competition among factoring company’s that borrowers are getting the best deals available. So purely from a cost to the borrower standpoint, the daily earthquake eruptions of the financial industry will not result in radical changes.

Change in the factoring industry will be more indirect. There will be much more scrutiny on the credit worthiness of the account debtors (customers). With the downturn on the overall economy, the health and well being of the commercial business is paramount to retaining a solid credit rating. Unless the customers of a factoring client can keep their financial condition on a positive course, the factoring company will begin to have issues making their advances on invoices. So the ripple effect here will be on credit worthiness not increases in cost to borrower.

With the above in mind, another indirect affect of the current credit problems will be the banks that fund the factors. Factoring companies have lines of credit that form the basis of the resources used to make those advances on invoices. The banks typically are watching closely at the operational conditions of the factoring company. So their hands are tied when it comes to extending extra credit to a favorite customer.

Can gaining access to operational cash flow from invoices be a useful tool in the right situation? Invoice factoring is used primarily by companies involved in labor intensive contracts who have strong creditworthy customers. Whenever a factoring client secures a nice contract, they will most likely bring on extra employees to do the work. They need to get paid regularly. The factoring company insures timely payroll and steady consistent performance. By verifying time sheets an invoice can be instantly funded and alleviate the lag time of waiting for the invoice to be paid 30 – 40 days later. Once the customer pays the invoice to the factor, the transaction is complete. Accounts receivable factoring is very simple to understand with tremendous benefits to a growing business.

Commercial financing, like invoice factoring, regularly requires the owner of the company to sign a personal guarantee waiver. For a factoring company, using a personal guarantee is not a preferred method of repayment. From the factors standpoint, it is seen as a deterrent to fraudulent behavior.

When factoring invoices the turnaround on repayment is normally 30 - 45 days. The process of recapturing funds from an advance by going after the owner personally could take a couple years by the time it goes to court and a judgment is rendered. It simply takes too long to be considered a viable option. Factoring companies generally require a personal guarantee for two reasons; 1.) protection from a planned conspiracy to defraud, and 2.) the factoring company has its own line of credit, and its bank requires that all factoring clients sign one.

By signing a personal guarantee the factor will not be looking for you to repay an unpaid invoice out of your pocket. It is more expedient to take the lost amount out of the reserve or set up a repayment plan by reducing the advance rate. Make sure you understand the true liability of signing a personal guarantee for accounts receivable financing before making a blanket statement like you refuse to sign one.

When investigating invoice factoring, you will quickly realize that factoring requires transparency throughout the process. The notion of not letting your customers know you are involved in a commercial finance transaction is wrong. If the perception is of your customers thinking the business is in trouble, just because you are utilizing accounts receivable financing as a tool for growth, you need to change your perception. Customers worry about performance. They want a job done well. Using a factoring company to help the company run better is a good thing. Qualifying for commercial financing through factoring is a good thing, as opposed to being turned down. As long as your perception is on growth and success, your customers will be happy to work with you on a invoice factoring transaction.

To learn more about factoring, read on, or click here, thanks.

Business owners looking for investment capital need to understand the value of what those dollars represent. When you sell off parts of your company and gain new partners and shareholders, they don’t want to learn you are paying the electric bill with their investment. In other words, getting equity money is a long hard fight involving a lot of time and resources. The investors need to know that the business is run properly, meaning, you know capital priorities. And capital priority number one is – improve shareholder value. Every dollar should be used to build the value of the company. Paying bills does not increase shareholder value.

Here is where invoice factoring is very useful. By utilizing accounts receivable financing you are not taking on any net term liability (and decreasing value), and you can put the cash flow to work paying bills, thus protecting the investment kitty. A factoring company takes into account the burn rate associated with venture backed companies and can still put the funding in place. Keep the eye on value, and use receivable factoring as the necessary financial tool to keep the momentum growing.

If you’re looking to raise capital — whether a bank loan, invoice factoring or equity venture capital — you will be better off with a business plan. The business plan is necessary for attracting and convincing investors but it’s also an operational document to guide your company on the path to achieving its goals.

Growthink’s 2008 Business Plan Guide is a free resource that provides tips and advice on the business planning process. Since 1999, Growthink has developed successful business plans for more than 1,000 growing companies. The guide shows how to prove the feasibility of your venture, develop your business strategy, and prepare your plan for investors. It also defines the particular sections of the business plan, plus identifies key factors to include, such as highlighting past accomplishments, overcoming barriers to entry and using marketing studies to show a clear understanding of customer needs.

Download the guide for free.

Invoice factoring from a factoring company is not necessarily going to be available for every business owner. Companies without invoices, or just trying to get formed will need access to other forms of capital. One option is the local bank. Local banks are tasked to help small businesses. If the amount needed is fairly small, under $25,000, you might qualify for a signature loan. The loan is made out to the company but you are personally signing for the amount borrowed.

In order to secure a signature line of credit act like a business owner trying to get a loan. Put together a package that includes; information about your business, a list of customers you have lined up, show what money you have already invested in the business and most importantly – what are you going to use the capital for, and how do you plan on repaying the loan. Then take your package around to local banks, but don’t be discouraged if a particular branch turns you down. Go to a different branch and try again. What you are looking for, if your business idea is good enough, is an “internal champion.” Keep going until you find some banker, who believes in you, willing shepherd the loan through the banking process.

It’s time to learn of the rewards having the US Government as a customer. The Fed pays, it never runs out of money, has insatiable needs and once you are accustomed to working with the government, they start knocking on your door. The General Services Administration (GSA) has many program tracks enabling small businesses to become vendors, including training, forms, and contacts. They even have people dedicated to making sure small businesses get their foot in the door with the Federal Government.

The fascinating part of working with the government is they have to provide extremely detailed specs on the work, what is to be done, how it is to be done, how much it should cost and what skills will be required. And if you bid on a solicitation and do not win, the government has to provide the exact reasons why they passed on your bid. You can do searches on your competitors and possible opportunities available in hundreds of agencies.

With a contract in hand, having a factoring company on board can be a lifeline to the capital you need to perform on a consistent basis. Whether helping to purchase more products or keep up with increasing payroll, the ability to keep the cash flow moving is going to be critical to the ongoing success of working with the Feds. Using accounts receivable financing to immediately get paid on government invoices insures successful performance of contract specifications.

Visit the GSA and get on the road to landing the biggest customer in the world.

Are you a government contractor? Are you looking to network with other contractors in order to gain access and learn more about selling to the government? Look no further than The American Small Business Coalition. Led by the engaging Guy Timberlake, this association of government contractors is leading the way to creating a coalition of like minded business leaders who ecshew honor and integrity in the procurement process. With various levels of membership, constant networking, advisory panels, and training opportunities the group takes its mission very seriously. Join up and gain access to a comprehensive utility for information, relationship building, and news on the US Government sector.

Are you sure getting a loan from a bank is the best idea? Many business decision makers don’t even look into factoring invoices as an alternative because they found a bank that will offer a loan. The problem lies in the size of the loan. If the loan amount is not enough to cover a surge of new business it could have a detrimental effect on continuing operations. When a company reaches the maximum limit of the loan they usually have very few options to raise additional capital. Invoice financing is a good choice for a young company that is growing faster than their balance sheet. The bank will look at what your company has done yesterday. A factoring company is interested in what you are doing today and tomorrow.