When factoring invoices for working capital the entire process revolves around the account debtor or “customer” making their payments directly to the factoring company. The way this usually works is; first you submit info about a potential customer to the factor who finds credit history to determine whether the account is able to be financed. If the customers’ credit history is deemed creditworthy then it is safe to assume that the invoice will be factored.

Next, once the sale has been completed – the product or service has been delivered, the factoring company must notify the customer that you have assigned the proceeds of the invoice to a third party (the factor.) This is a legal obligation when assigning payments due to you, but payable to a third party. From a legal standpoint there is no opaqueness to invoice factoring. Actually the factoring agreement is a Purchase and Sale Agreement whereby the client is selling the invoice to the factor.

Finally the factor contacts the customer to verify that the invoice represents the delivered services and to insure that the ‘remit to’ address has been correctly entered into their system as going directly to the factor. There are no situations in factoring where the funded client receives payments from a customer and passes them along to the factoring company.

Typically every payment from a customer where invoices are being funded must go to the factor. The accounts payable department of the customer will become confused which payment goes where. So once an account has been “turned on,” all payments from that customer go directly to the factoring company, although not every invoice must be factored. Any payment of a non-factored invoice is sent on to you and no funding fees are taken out.

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Most invoice factoring companies are limited to purchasing invoices that never age more than 90 days. Accounts receivable financing typically is for businesses that issue 30 day net term invoices and have a history of getting paid in a timely manner. A business model that allows for bi-annual or annual payments may not be a candidate for factoring. Trying to finance an annual contract with a factoring company is also limited or unavailable.

The primary reason for this stems from the arrangement a factoring company has with its funding source, usually a bank. The bank lends money to the factor who in turn makes capital advances to their clients. When the bank is calculating the available credit it issues to the factoring company, all outstanding invoices that have aged over 90 days are considered a “non-performing asset” and therefore are deducted from their available credit line. Now there are cases where an errant invoice does go over 90 days. In these situations a recently finished job with a new invoice is swapped for the overdue invoice.

An important distinction is, the clock at the factoring company starts on the day of funding, not the date on the invoice. So a client may choose to submit an invoice to their customer and then hold and wait for a period of time (week or two or three) before submitting it to the factor for the advance. Thus avoiding some of the “funds in use” fees associated with the factoring.

Finding money from a factoring company is just like trying to make a sale. You have to convince the buyer that your company is worthwhile. To do this requires putting the extra effort into explaining who you are, what your company is about, and why it would be a good idea to buy from you.

When applying for invoice factoring, sure you can just fill out an application, but if you feel there is more to your company than a form permits, make the effort to express it. A factoring company may get hundreds of applications, why is your company different? What makes it unique and extraordinary? In any endeavor it is best to show a broad picture of how you plan to grow and succeed. Especially if there are any blemishes in the story, having more to say may overcome less than perfect situations. It is better not to hide behind problems that businesses incur every day, rather, put your best face forward and show how your company can overcome adversity and flourish in uncertain times.

Like all other types of commercial credit, with receivables factoring, as a business owner you are rewarded when the company is well run and organized. When a business is seeking accounts receivable financing, if their accounting is current, the profit margins are known, the personal background is clear, and the company has good credit worthy customers, then they will have an easier time going through the due diligence process. These things show that the business owner is serious, knows what it takes to run a company, and has a history of playing by the rules.

If a business contacts a factoring company as a last resort because all other forms of financing have turned them down, they will find that in commercial lending certain issues are always in play. The factoring company has to be extra careful whenever the story doesn’t seem to add up, or the history of how the company or business owners manage their affairs is questionable. Just because it’s factoring doesn’t mean it’s not going to have the all the safeguards in place to protect the transaction.

As a business owner looking for help financing part of your business, it is important to understand the fundamental differences of a bank line of credit and a term loan. They are used specifically for different purposes. Applying for the wrong type of loan may cause problems later on as the business grows.

A line of credit (LOC) is usually considered a short term loan. The payments are interest only based on the outstanding funds in use. As you draw down on the line, using it to pay bills, interest is accrued monthly. The line is like an open checkbook for ‘use as needed’ purposes. The critical nature of the LOC is the necessary discipline to put funds from income back to pay down the line. There should be a constant flow of money coming from the line to pay bills and then replenished as customers pay for your goods or services. When applying for the LOC, the bank is typically looking for historical cash flow. What does the revenue look like? Is it steady or fluctuates wildly? The bank will take a conservative view of the existing accounts receivable to get a baseline. For the most part a bank will not be able to consider potential new business when considering a LOC credit limit.

A term loan is a fixed funding transaction. It is a onetime loan based on cash flow of the business plus certain collateral pledged against the loan. The loan should be used for a major expenditure rather than daily cash flow for the business. All the proceeds are available at the time of closing, not like a line where funds are circulating. The payments are interest and principal based on the amortized terms of the loan. For example; a $100,000 at 8% interest over a 5 year term. The bank will assume an ownership position on the collateral, meaning the collateral cannot be transferred or liquidated. The historical cash flow of the business is critical to securing a term loan. The lender needs to see that loan payments will not have an adverse affect on the business operations. Term loans are used to purchase real estate, equipment, for build-outs, or franchising.

There are situations where a LOC that has been used to the credit limit is converted into a term loan, so the business will have to make monthly payments to pay off the old line. The problem becomes the business no longer can gain access to additional funds while the loan is outstanding. Access to capital is the lifeblood of any company, and lack of capital will starve a growing business.

There is a distinct and real difference between a Factoring Fee and an Annual Percentage Rate when discussing the price of interest on a loan. Comparing the two is like saying that an all season radial tire is the same as a bicycle tire. They’re both round, made of rubber, help you get somewhere, but not interchangeable. Therefore multiplying a 30 day invoice discount fee by twelve does not reflect a reasonable figure.

When a factoring company makes an advance on a 30 day invoice, we expect to be repaid somewhere well within a 90 day time frame, usually between 27 and 45 days. This means the risk involved is over a short period of time. This allows the factor to make quick adjustments accordingly. This short leash is reflective of the risk the borrower brings into the equation. A bank on the other hand will make a loan that they expect will be paid over a year or more. They are making a calculation that your business will be the same or better over that period of time. If there is a risk that you might not be able to pay back the loan, no loan.

With factoring invoices, the decision to advance funds is primarily based on the creditworthiness of the debtor. It is your customer who will repay (pay off) the advance (see this). So if you try and compare an annualized rate with a short term rate, you must at the same time compare a company that can qualify for a long term loan and one that cannot. Those two companies are not the same, neither is the cost of funds.

TeamingUSA.com is a fantastic organization for entrepreneurs looking to get into the Federal market. The website provides a platform whereby your company can list, for free, all its capabilities. Using NAICS codes and keywords, companies looking to partner up to win a contract award can find each other. Here is what they say;

Government agencies — federal, state or regional — represent a tremendous market for small businesses. According to the Small Business Administration, annual spending by government agencies with small businesses reached $83.27 billion for fiscal year 2007, up from $77.76 billion the previous year, and continues to grow. Additionally, stimulus funding is providing even more opportunities for small business owners to sell to the government. Many contracts include a variety of goods and related services under a single bid or RFP. The government refers to this as contract consolidation; in other circles it’s referred to as “bundling.” Consolidating contracts increases government efficiency by reducing administrative overhead of managing multiple contracts.

One of the smartest strategies for competing in a government market with increasing numbers of bundled contracts is through teaming—finding and joining forces with the right partners for the right contracts. Teaming is the strategy for small businesses looking to win government contracts. Finding companies with complementary skills, resources and capabilities gives you the opportunity to expand your existing government business and increase your bottom line.. Teaming also helps eliminate barriers an individual business owner may face vis-à-vis geographic reach or workforce. Finally, teaming is also a tactical starting point for gaining experience and credibility in the government market if you are relatively new to the field.

A factoring company has to be particularly careful when financing invoices related to agriculture products and services. Thanks to the Perishable Agriculture Commodities Act (PACA) which congress passed for the protection of suppliers and sellers of perishable agriculture products. Because the accounts receivable that is generated from the sale of perishable products can be liable to the Act it is cause for concern for commercial lenders. Like many well meaning laws enacted for the protection of hard working companies, the trouble is in deciphering the fine print. There are potential problems in the interpretation of how the Act offers protection as it pertains to a factoring company having to return proceeds paid on behalf of a customer. This is another instance of invoice factoring specialization. A few factoring companies work primarily with agriculture business and therefore know how to properly interpret the law. To read more detail on how the law works read this article by Andrew Cardonick.

If you are doing work for a very large company or even a U.S. Federal government agency, but you actually invoice another company, they are the PRIME contractor who then invoices the large end user entity. That makes you the SUB contractor. Even though the end user is a large organization and probably creditworthy, when factoring invoices it’s the actual payor that has to be have a solid credit history. This may create an issue when considering the creditworthiness of the account debtor. A factoring company only can consider the credit availability of the actual company making the direct payment.

Many large companies create a preferred vendor list. Any new vendor that wants to do business with that large end user has to go through the preferred vendor. It makes life more efficient for the end user because they only have to keep track of a few vendors. But if you end up as the sub contractor in these occasions it places a layer between you and getting paid. You may be at the mercy of the preferred vendor.

The best thing you can do is dilute the risk by continuing selling your services so that the amount of your sub contract invoices is not the majority of your total outstanding account receivables. Any time your invoices are considered high risk you will have trouble securing credit against them.

If you are considering using invoice factoring for your ongoing operational capital needs remember it should only be used as a temporary bridge to get to institutional (bank) financing. By factoring your accounts receivable to get through a intense growth period you can effectively maneuver through the tough cash squeeze stage as the business gains momentum. Access to capital is key to growing a successful business. By securing bank financing too early in your growth, you may not qualify for the proper level of financing which could potentially leave your business high and dry later.

Accessing capital by factoring your invoices is a valuable solution until you get enough critical mass to qualify for the size of loan to bring in stability. But factoring should be considered as a strategy to get to the next level, not the end all be all of your financing needs. Factoring is a necessary step that brings credibility to your operation by showing that you have the required resources and capabilities to deal with commercial financing.

The basic invoice factoring transaction has three parts. First is the “advance,” which is the percentage of invoiced dollar amount that is funded initially. It is the percentage of the total value of the invoice. For example, if the invoice submitted is $10,000 and the advance rate is 80% then the advance will be the $8,000. This amount is wired into your company bank account when the invoice is funded.

Next is the “reserve.” This is held back until the customer pays the invoice directly to the factoring company. Once the payment is made then the reserve is released. Factoring companies handle the reserve differently, so be sure to understand what the offer specifies. Some companies hold a semi-permanent reserve, some batch invoices and only release the reserve when all the invoices in the batch have been paid. For example, every Friday our firm releases the reserve for all individual invoices that have been paid during the week.

Lastly is the “discount rate.” This is the fee for funding the invoice. Again each factoring company handles this a little differently. When the invoice gets paid, the discount fee is taken out of the reserve and the balance is sent on to you. All factoring companies follow this concept basically the same way.

The Advance, the Reserve, and the Discount Rate make up the invoice factoring deal.

Highly influential speaker / thinker /doer Seth Godin writes about the need to rethink the business plan. Currently business plans are “often misused to obfuscate, bore and show an ability to comply with expectations.” To seriously disrupt the status quo he suggests dividing the plan into five sections.

* Truth
* Assertions
* Alternatives
* People
* Money

Speak to the heart of the matter, rather than the template you think is required. If the idea doesn’t lift off the page, it probably will never get off the ground. Read his blog post here and pay attention regularly to his space - you will definitely learn something.

It appears that all the economic clouds are gathering to form a perfect storm for receivables factoring. The previous down cycles still had banks offering commercial financing to marginal borrowers. Marginal meaning that the borrower might not be quite ready to secure funding, but the banks were willing to make the loan happen. Not today. Today the name of the game is protecting assets first and foremost. With this in mind, a factoring company can play an important role to help revitalizing the troubled economy. Because accounts receivable factoring relies on the creditworthiness of the customer rather than the financial condition of the borrower, invoice factoring can be the best short term solution to accessing badly needed working capital. And invoice factoring can be obtained within days with relatively little amount of headache and paperwork.

Understanding the relative cost difference between invoice factoring and purchase order financing is dependent on the work being done and the risks involved. With factoring, you cannot finance an invoice until the work is completed and accepted by the customer. Whether you are providing a service or selling a product, the customer has to be satisfied with the work before a factoring company will make the advance. Pre-billing for work not completed will not be accepted by a receivables factoring company. The risk for repayment to the factoring company is based on the creditworthiness of the account debtor (customer), therefore the cost is appreciably less than P.O. financing.

Purchase Order financing is for companies that are selling products. The best scenario 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 P.O. has been verified, money can be secured to help a supplier fulfill the order. The order is delivered and the P.O. finance security position must be paid off by the factoring company. Therefore many businesses use invoice factoring in conjunction with P.O. financing so the transaction goes through without interruption. Again to be clear, invoice factoring is based on the ability to pay by the account debtor, purchase order financing is based on the performance, and will the borrower fulfill the order? So PO financing is considered to be riskier and more expensive.

Wikipedia on invoice factoring: Factoring is a financial transaction whereby a business sells its accounts receivable (i.e., invoices) at a discount. Factoring differs from a bank loan in three main ways. First, the emphasis is on the value of the receivables (essentially a financial asset), not the firm’s credit worthiness. Secondly, factoring is not a loan – it is the purchase of a financial asset (the receivable). Finally, a bank loan involves two parties whereas factoring involves three. The three parties directly involved are: the one who sells the receivable, the account debtor, and the factor.

The receivable is essentially a financial asset associated with the debtor’s Liability to pay money owed to the seller (usually for work performed or goods sold). The seller then sells one or more of its invoices (the receivables) at a discount to the third party, the specialized financial organization (aka the factor), to obtain cash. The sale of the receivables essentially transfers ownership of the receivables to the factor, indicating the factor obtains all of the rights and risks associated with the receivables. Accordingly, the factor obtains the right to receive the payments made by the debtor for the invoice amount and must bear the loss if the debtor does not pay the invoice amount. Usually, the debtor is notified of the sale of the receivable, and the factor bills the debtor and makes all collections. The factor usually charges the seller a service charge, as well as interest based on how long the factor must wait to receive payments from the debtor.

Read the Definition, Overview, History, etc. everything you need to know about invoice factoring.

Whether trying to secure funding from a factoring company, a bank, leasing company, venture capital firm or seed investor – one bit advice that will make things go much easier. “Do what you say you are going to do.” This one phrase can make all the difference when talking about using other peoples’ money. For the most part a capital raise is put together by a management team. Processing an application for invoice factoring is a fairly simple task. A factoring company can get an account set up within a few days, if the client cooperates with providing documents needed to complete due diligence.

Usually a simple application and an accounts receivable aging report will be enough to get a term sheet for receivables factoring. But once the application is submitted there are a handful of additional documents that are necessary, just like applying for a mortgage. The hang up often happens when the factor is looking for these additional due diligence documents. Unfortunately this is usually preceded by the borrower/client being in a frantic rush. In such a hurry that it sometimes takes days and weeks with constant reminders to get basic forms completed and returned.

Invoice factoring can be the fastest access to capital for a growing company, with a little help.

Invoice factoring from a factoring company is not necessarily going to be available for every business owner. Company’s who do not have invoices or are just trying to get formed, will need access to other forms of capital. Even with all the bad news, 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 the owner will need fair to good personal credit. It’s important to put together a document 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, personal tax returns, and company financial statements. The key to securing a loan is to acknowledge how much you will need, 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 a banker, who believes in you, and is willing to shepherd the loan through the banking process.

The threshold for a small signature line of credit for a business owner with good credit should be easy to cross. One added benefit to offer the bank is to bring them your banking deposits if you get the loan. Having a small signature loan will allow you to have access to receivable factoring once the company is viable enough to qualify.

Because a factoring company wants to make sure a business is being run properly, we take a good look at a prospective borrowers financial statements. In this post Ken Kaufman, Founder & CEO of CFOwise®, stresses the importance of having bookkeeping that reflects the true accounting of the business. Poor quality financial statements are a road map to nowhere, leaving the driver totally in the dark when it comes to planning and operating a company.

Some examples he raises are; revenue incorrectly recognized, discounts buried, job costing forgotten, reconciliation dismissed, fixed assets expensed and liabilities overlooked. Read through the entire list of 20 and see if you are neglecting anything.

The most important lesson here is to reach out for professional help when you need it, and before it’s too late. A good handle on the bookkeeping of a business can reap rewards by moving in the direction of profitability and away from stagnation or destruction.

It’s typical for companies to outsource internal services to firms who provide such services for efficiency. Services such as payroll taxes, human resources, bookkeeping, collections, and accounting are commonly outsourced. Invoice factoring may be considered “outsourced cash flow.” By factoring accounts receivables to better manage and even out working capital short falls, a company can save time and money lost on scrambling to make ends meet. A factoring company provides credit management and collections capabilities that are built into the factoring process and are included in the cost of funding. These added features can offset the price of using factoring when avoiding a bad account debtor or collecting on a difficult invoice is taken into account. When considering the stigma attached to using invoice factoring, it may be better to recognize it for what it is, outsourced cash flow.