Do you or someone you know have a company that needs cash NOW and has receivables on the books? Then read this short article. In about 2 minutes you will learn about a good way to raise cash quickly.
Receivables often represent one of the biggest assets on a company’s balance sheet. They’re often right up there, in terms of size, with inventory. Both represent a significant amount of working capital that is tied up and unavailable to meet a company’s current cash requirements. And, both can be converted to cash fairly quickly. This article discusses the practice of “factoring”, converting receivables into cash. Factoring can be a good option when cash is tight because a company is facing a seasonal downturn, unexpected events, or when above normal cash is needed to capitalize on an opportunity.
Many companies don’t consider factoring as a good practice because it is more expensive than a line of credit from a bank. But, when a company’s line of credit isn’t adequate, or a when a line isn’t even available and there are no other sources of cash then factoring is a great option as long as the seller and the invoice debtors meet a factor’s minimum qualification requirements. The process is much less involved than getting a bank loan.
Here are a few things to know about factoring.
- Factoring is not lending per se. It is the sale of an invoice, or invoices, at a discounted price to a factoring company, sometimes called an Asset Based Lender. Invoices that have a lien attached are not eligible.
- Invoice debtors typically make payment by sending checks to a bank lock box that has been set up by the factor rather than to the company who sold the invoice.
- There are ‘recourse’ and ‘non-recourse’ factors. A ‘recourse’ factor can go back to the client for settlement if payment is not received in an agreed upon time frame, e.g. 90 days. In other words, the seller of the invoice guarantees payment. This type of factor is less aggressive in collecting than a ‘non-recourse’ factor who owns the invoice and the risk of collecting on it.
- Factors can buy all open invoices for one or more customers of a client. Some factors will buy individual invoices in a practice called “spot” factoring. And, they often specialize in, or stay away from, certain industries.
- Cash is typically available in 24-48 hours. And, because this is not a loan, there are no loan covenants. But, there may be a lot of documentation required for any given invoice such as; a purchase order, vendor agreement, bill of lading, tracking information, written verification and, final acceptance.
- Rates vary depending on the degree of risk the factor assigns to the debtor and to the selling company. They can range from about 1% to 3% per month. On an annualized basis the cost of this money can exceed 20% but, the cost must be considered in light of the benefits.
- Factors will normally provide 75 – 90% of the value of an invoice at the time of the sale and will withhold the remaining amount (called a “reserve”) pending successful collection from the debtor. At that time the seller will be given the remaining value of the invoice minus the factor’s fees.
- An online alternative to working with a local factor is called “The Receivables Exchange” (www.receivablesxchange.com). That service enables a company to put an invoice online so that factors around the country can bid on it – Ebay style. Cash is received in days once a company is registered with the service and has listed invoices on it.
- Some factors will also work with a company to help it secure large purchase orders without buying purchase orders.
As an example as to how factors can differ, here is a very brief description of two factors in the Phoenix area.
a) Robyn Barrett of FSW Factoring is a full recourse factor who does NOT work with companies in the construction, trucking or agriculture industries. When considering a new client she is primarily looking at the character of the borrower/client and the creditworthiness of the debtors/customers of the client.
b) Phyllis Rector of The Interface Financial Group, on the other hand, specializes in spot factoring FOR the construction industry. When considering a new client, her primary concern is whether the prospect has jobs with at least 2 different general contractors so that she can be sure that her client can substitute an invoice of one customer with that of another should there be a problem. She also says that the client has to be in business at least 6 months with revenues of at least $20,000 / month.
About the Author
Mr. Casebere is a partner with the firm B2B CFO®, a national association of highly skilled Chief Financial Officers who provide part-time assistance to small and mid-market companies. Mr. Casebere has over 30 years of experience in corporate finance helping companies of all sizes achieve their goals. He is an expert at helping business owners increase their profit margins while improving cash flow and maximizing company value. He holds an MBA, is a Certified International Credit Professional and Project Management Professional. You can contact him at: firstname.lastname@example.org .