The steps to considering invoice factoring as a possible solution for commercial financing begins with an internal examination of your company.
First, does the business have any existing conventional bank financing in place? And if yes, what was the collateral used to secure the loan? The possibility of a UCC-1 filing with all business assets would prohibit your company from borrowing from other sources like a factoring company. You should always know your UCC status. Especially when you have paid off a loan, make sure the old lender files a UCC-3 termination to clear up your account. So many times we begin our process by going back 5 – 10 years clearing out old UCC filings trying to find contacts with an institution to get them do a release.
Next is profit margin. Whatever your company does whether it’s selling a product, either distributing or making it or offering a service – you need to know the profit margin on a completed sale. Because factoring is an ongoing transaction of providing capital against outstanding invoices, the cost is a percentage of the invoice face value. This means the cost is a percentage of the ultimate profit a company will earn on that invoice. If the margins are very thin, under 10%, then invoice factoring is not a good solution. The best scenario is a company with strong margins, better than 20%. The company is booking too many contracts so the cash flow cannot keep up with products or services being rendered.
The point of factoring is to be able to take on exponentially more business and keep up with paying for supplies, labor, taxes and fixed costs. Factoring is not really for developing a new product or creating a sales and marketing campaign to get fresh business.
Once you have determined that receivable factoring is the right answer for the mission, here are the simple steps that mechanically make up the transaction:
- A credit report of each account debtor (customer) will be done to determine the limit of funding available for them. For instance, they might have unlimited credit, or funding up to a certain dollar amount. But a limit is considered any outstanding amount so if you bill for a second invoice while the first is still unpaid that might push the credit limit.
- The customer is notified that you have assigned the proceeds of the invoice to a third party, in other words, when they make the payment they send it to a new address.
- The customer at the same time verifies that the product or service they received has been accepted and the invoice shows up in their payment system.
Really this is all there is to factoring. These three steps are done every day to countless sets of invoices in order to receive advance funding on an outstanding invoice. And once the factor and the customer are aware of each other on reoccurring transactions – you bill them weekly or monthly, this checking is usually done through a series of emails or quick phone calls.
Once the three steps are accomplished the factor will do a bank wire to your account with a percentage of the invoice amount which is called the Advance. Typically it is 80% of the invoice. The remainder, called the Reserve is held back until payment is made by the customer directly to the factor.
Upon receiving the full payment the factoring company will deduct the fee associated with the transaction from the reserve account and send the reserve onto you. This completes the transaction; most factors treat each invoice as a separate purchase although some still group them so you need to ask about how they operate.
The details of how funds are sent, how credit checks are done, how notification and verification are done are particular to any factoring company. So asking a few questions about their execution is helpful to understanding how your company will interact with the regular routine.
Finally, it’s important to find a good factoring partner who has experience with your particular industry or location. There are industries where factors specialize primarily due to their special way of doing business, for example; trucking, healthcare, construction and international sales.
Remember factoring is unique in that there is regular communication and interaction with personnel and activities related to getting funding. Making sure you get the right match will keep you focused on growing your business.
Gary Honig
Company: Creative Capital Associates Factoring Co. Nov 11, 2015