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Looking at Factoring in a Whole New Light

Guest post by: Tracy Eden

Article Overview: In the post-financial-crisis world in which we now live, most business owners and entrepreneurs view commercial financing in a completely different light than they did before. With traditional bank loans getting harder to obtain, many owners have had to look “outside the box” for the capital they need to sustain and grow their firms. In doing so, many have discovered (or sometimes rediscovered) the potential benefits of asset-based lending and factoring. Sarsha Adrian, a senior consultant with Graber Associates, a marketing and research firm that specializes in financial services, made this observation during a recent webinar. Read on for more details on her thoughts and comments.

Looking at Factoring in a Whole New Light

In the post-financial-crisis world in which we now live, most business owners and entrepreneurs view commercial financing in a completely different light than they did before. With traditional bank loans getting harder to obtain, many owners have had to look “outside the box” for the capital they need to sustain and grow their firms.

In doing so, many have discovered (or sometimes rediscovered) the potential benefits of asset-based lending and factoring. Sarsha Adrian, a senior consultant with Graber Associates, a marketing and research firm that specializes in financial services, made this observation during a recent webinar.

“Factoring has re-emerged as a way for fast-moving, aggressive businesses to meet the critical need for working capital finance,” Adrian said. “There’s a change of opinion going on now—a mind shift about what factoring is. It’s almost like factoring is changing its name to ‘business-to-business payment financing.’”

No Longer a Last Resort

Meanwhile, a recent Wall Street Journal article discussed the rising popularity of asset-based lending, noting that this former “last-resort finance option” is gaining ground as traditional sources of capital dry up. “Asset-based lending has become a popular choice for companies that don’t have the credit ratings, track record or patience to pursue more traditional capital sources,” the article stated.

The volume of asset-based loans grew to nearly $600 billion in 2008, an increase of more than 8 percent, reports the Commercial Finance Association, and they expect that volume grew again in 2009, but this time by double digits. Compare this to syndicated lending, which decreased by 39 percent in 2009.

“There’s a huge difference now in the way business owners are looking at these financing options,” said Adrian. “They want some predictable way of understanding their cash flow. They are interested in an instrument that will finance their transactions, and they look at factoring as part of their payments.”

Businesses may turn to factoring for a number of different reasons. In her webinar, Adrian noted a few of the most common:

· Improve cash flow

· Build up cash reserves

· Avoid additional debt

· Don’t qualify or can’t wait for a traditional bank loan

Sixty percent of a typical firm’s cash is tied up in receivables, according to Adrian, and waiting for payment can put serious pressure on cash flow. “Selling receivables at a discount by factoring can help bring in cash quickly.” Another strategy used by some firms to speed up cash flow—offering so-called “2/10, net-30 discounts”—isn’t always effective, she adds, “because customers often take the two percent discount and still pay in 30 days.”

It’s Not a Loan

Factoring differs from traditional lending in that it is the actual purchase of accounts receivable by a bank or commercial finance company (usually referred to as a factor) from a business, not a loan of funds to the business. The receivables are purchased at a discount, typically 2-5 percent of the invoice amount, which constitutes the factor’s fee.

The factor advances a portion of the receivable (usually 80 percent) to the business immediately and the balance after it has made collection, less the discount. In most client-factor agreements, the business agrees to factor a minimum amount of money each month for the length of the contract period—usually 12-18 months. “In this way, factoring essentially becomes an unlimited line of credit,” said Adrian.

There are two primary types of factoring: recourse, in which the factor can demand payment from the client if its customers fail to pay receivables, and non-recourse, in which the factor cannot demand payment from the client even if its customers don’t pay. Because the factor is heavily dependent on the reliability of its clients’ customers, it will be especially concerned with their creditworthiness, carefully analyzing them and performing credit checks on potential new customers.

“What businesses like about factoring is that it’s not a loan,” said Adrian. “They’re not borrowing money so they’re not tying up collateral (other than the receivables that have been sold) or increasing the leverage ratio on their balance sheet. They’re getting immediate cash and they avoid doing all the paperwork associated with bank loans. Many see factoring as being much more convenient compared to bank financing, which is painfully slow.”

Another traditional type of asset-based lending involves the leveraging of accounts receivable, and in come cases inventory. Here, companies borrow money against the value of these assets, essentially using their receivables and inventory as collateral for the loan. The bank or finance company will advance funds to the business based on a calculation of the eligible outstanding receivables and inventory. Because these assets are so fluid, it requires a different level of monitoring than does traditional bank lending.

Overcoming Hesitations

One hesitation some companies have with factoring is unease about turning over their client lists to factors for collection. According to Adrian, this is much less of a concern today than it used to be. “A lot of businesses are using payment companies now in the normal course of doing business, and the customers’ names are known to them, so it’s not really an issue for most companies anymore.”

While some banks (mostly large ones) do asset-based lending, most is done by commercial finance and factoring companies. Your bank may refer you to an asset-based lender, or factor—if so, be sure to examine them thoroughly and perform careful due diligence. Professional experience and adequate capitalization are crucial, so ask how long they’ve been in business and how well capitalized they are.

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Article Tags: assetbased lending, commercial financing, factoring, working capital finance
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Different Types of Funding - Finance for business can be obtained through a number of different sources. Let's review some of those channels to help you decide what's right for your business needs: Grants There are over 930 different EU and UK grants and loans available from over 100 issuing bodies. This is the cheapest form of finance and an important part of the funding package that companies and individuals need. We can help you find your way through this maze. Technology Micro Projects: 50% of eligible costs up to £20,000 Research project: For a technical and feasibility study of an innovative idea for new technology 60% of costs up to a grant of £75,000. Development project: For development up to pre production 35% of costs up to a grant of £200,000 Developing an innovative idea: valuable for small companies and individuals at the start of a technical project: 75% of costs of hiring a mentor and consultants. Export To start exporting or moving into new markets grants of 50% of costs up to £20,000 each. Training and Education Knowledge Transfer Partnerships, Achieving Best Practice in Your Business, Investors in People Modern Apprenticeships New Deal for various grants. Environment BOC Foundation for the Environment: 25% to 50% of Project cost, typically £20,000 to £100,000 Clean up Fund: Emission reducing equipment up to 75% of cost Community Chest Fund: Up to £25,000 for projects near active SITA sites High Impact Fund: £150,000+ for larger projects near SITA sites Assisted Areas Regional assistance grants of between 10 and 35% for capital expenditure in less favoured areas of the UK. Loans Loans are an excellent source of finance if you have suitable security to borrow against or a reliable earnings stream. This needs to be planned and presented well to obtain funds. Credit cards Provides up to 56 days free credit if you play the game! Overdraft Banks are surprisingly supportive when presented with a well thought through plan and competent management. Bank Loans Lenders tend to look for a good business plan and security. Typically the loan is approved by a centralised back office function rather than the person you meet. Terms and rates depend upon the risk. Repayments can be very flexible to meet your specific needs. Mortgages These can include flexible repayment terms to meet your business needs. This can even be incorporated into your overdraft finance so that you have one flexible account for both personal/ business mortgages and overdraft Small Firms Loan Guarantee Scheme Up to two years trading: Up to £100,000 Over two years trading: Up to £250,000 However these are difficult to obtain and are a loan of last resort. Export Guarantee Scheme This is government backed insurance against appropriate export documentation. Mezzanine This is a halfway house between loan and equity. It can be an innovative way of raising funds for the more established business. Mostly for expansion capital. Equity This is not as easy as the papers would have you know. Only 1% of business plans received by Venture Capital Funds are successful. However, a good business proposition consisting of a strong demand for the product or service, management track record and a sound financial plan will enhance the chance of success. Business Angels These are high net worth individuals who are successful businessmen looking for investment opportunities. They can provide both time expertise and money. Typical investment size is £25,000 to £250,000 but can go as high as £2m for the right opportunity. Exit within 3-5 years. Venture Capital These are investment funds seeking high rates of return. However typically investments are over a million pounds. Some funds are targeted at lower amounts depending upon the sector and region. These funds are looking for exponential capital growth over 3-5 years. Asset backed finance This can cover machinery, sales invoices even sales orders. It can be a very flexible source of finance to the growing business Leasing This will cover your capital expenditure and spread the cost over a three to five year period. It is particularly useful if you do not have taxable profits to maximise your capital allowances. Sale and leaseback of a property you own is another good source of funds. Factoring Factoring offers a sales ledger administration and debt collection service. Up to 95% of an approved sales invoice is paid within 48 hours, quicker if required. Credit protection is also available to protect against a bad debt. The Factor will own and place a first charge over the book debts and they might also take other charges, depending upon the strength of the financial information. Invoice discounting Invoice Discounting can be Confidential or Disclosed; it depends upon the strength of the financial information. The service is the same as Factoring, except that the sales ledger administration and the debt collection is the responsibility of the client and not the Factor. Pre payment of the approved sales invoice is still up to 95% and the factor will still have a first charge on the book debt and therefore own the debt. This service can also have credit protection cover. All sales invoices need to be for a business to business debt, and some proof of delivery is generally required. Trade Finance This is funding provided against stock purchases, signed contracts and orders whereby the funder will prepay a certain percentage of the value Pension fund It may be possible to use your pension funds for a loan back to the business What do u think about it?
Re: Using factoring companies - [quote="BigJim22":3e4n6n63]I haven't used it myself but can see how it would be valuable for some entrepreneurs. It's hard when you get an order but don't get paid until 30, 60, or 90 days later. But it's also hard to give up $ to the factoring companies![/quote:3e4n6n63] ..."But it's also hard to give up $ to the factoring companies!" Great comment, Jim! However, it's not as hard as it may appear from the outside. Unfortunately, there is no free meal ticket with any financing option (other than gov. grants). The real question regarding the financial viability of factoring is this: I have 2 checks for you; one is for $100 and you can have that one in a month; the other one pays you $80 now plus another $15 in a month. Yes, you net 5 cents less on the dollar with option 2, but if you can take the first $80 now and turn them into $90 or $100 (e.g. more sales!) in a month, then you've not only off-set the loss but actually grown your top and bottom line. Factoring is really much more like running a price promotion. Just look at all the sales events that are happening daily. Companies discount their goods by 10% - 75% only to sell more volume. What are the costs of these programs? Another good example are credit cards! If you as a merchant accept credit card payments from your customer, you're already paying 2% - 5% of each sale to the credit card company. That's the same principle as factoring! Or how many businesses offer a 2% net 10 days discount to their customers, only for them to pay within 10 days? By the way, I can beat those 2% net 10 hands down with our factoring rate! And then there are traditional loans.... you always have to pay back the principal AND interest periodically, no mattter how the business is doing. With our factoring programs there is no principal or interest to be paid back, and the "cost of factoring" is tied to sales and cash flow (i.e., when an invoice actually gets paid and after you have already received the money). The objective truth is that factoring is not the right solution for everybody. Used wrongly or irresponsibly, it can do a lot of damage to a company. But used for the right reason and under the right circumstances, a good factor and factoring program will do miracles for a company's growth (or survival). And in these situations, the $ that go to the factoring company become totally moot. It will truly be the famous win-win. Best, Ralf


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