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   ARTICLE   |   From Scotsman Guide Commercial Edition   |   October 2005

Factor It In

This alternative source of financing could be right for a number of clients

In a past Scotsman Guide, I explained that hundreds of businesses nationwide use factoring as an alternative financing tool to aid with slow cash flow. Factoring is the purchase (by a factoring company, or a “factor”) of creditworthy, commercial accounts receivables belonging to a business in exchange for immediate cash for that business.

Accounts-receivables funding can help businesses fulfill many functions meeting payroll deadlines, increasing purchasing power, stimulating growth, improving collection time, keeping pace with growth or providing immediate increased cash flow ¾ without creating debt.

This month, I will answer many common questions about factoring as an alternative source of financing.

Question: Why should my clients factor?

Answer: Factoring is a needs-based product. If a business has no need or desire to improve its cash flow or overcome temporary capital shortages, then factoring is not the right choice. Some businesses have no invoices available to factor. For many businesses, however, factoring is a viable alternative financing solution to their capital shortages.

Q: Is accounts-receivables funding a new financing option?

A: Accounts-receivables funding is one of the oldest forms of financing. Factoring began in the United States before the American Revolution, when merchant bankers in England advanced funds to colonists in exchange for raw or finished goods that were shipped later. Until the mid-1980s, most people thought accounts-receivables funding was only used in the textile and garment industries, in which terms typically exceed 90 days. Today, though, factoring is used for all types of businesses that extend credit terms to their customers.

Q: Isn’t factoring too expensive?

A: Bank loans are less expensive than factoring. Factoring, however, can provide a greater borrowing base than most lines of credit. This in turn will allow a business greater flexibility. Furthermore, if business managers can’t expand their lines of credit, then factoring will provide opportunities for improved cash flow. The bottom-line results can justify factoring fees.

Q: How is accounts-receivables funding from a factor different than accounts-receivables funding from a bank?

A: When making funding decisions, factors focus on a company’s creditworthiness while banks focus on the company’s financial history and cash flow. In addition, because accounts-receivables funding is not a loan, a company will have less debt on its balance sheet. Factors also make quick funding decisions, while banks may take weeks or months to approve a loan. With factoring, the only collateral a prospect is typically required to pledge is the receivables themselves, which leaves other assets unencumbered.

Q: Is a company eligible for accounts-receivables funding if it has a bank loan or line of credit?

A: If a bank has a lien on a company’s accounts receivables, that company should let the factor know right away. Factors will ask the bank to subordinate that lien. Because this is a common occurrence, most banks will accommodate the request.

Q: If a company owes back taxes, can it still apply for accounts-receivables financing?

A: Tax problems are handled case-by-case. Companies applying for factoring should let their factor know about any back taxes at the start so that it can discuss lien subordination with the Internal Revenue Service.

Q: If a company is considering filing for bankruptcy, is accounts-receivables funding still an option?

A: Chapter 11 is the only form of bankruptcy that most factors will consider.

Q: Can a factoring company purchase only a portion of a company’s invoices?

A: Yes, but remember that higher numbers of receivables purchased on a regular basis can result in more-competitive rates. Terms can be especially flexible when there are large numbers of invoices issued to a larger, rather than smaller, pool of customers.

Q: How long does it take to receive the first funding?

A: The initial funding typically takes five to 10 business days after receipt of the signed contract. If companies prefer, they can send some invoices to be funded with their signed contract. After the initial funding, companies can receive funds within 24 hours after verification.

Q: What percentage of a company’s accounts receivables can be funded?

A: Factors can usually fund as much as 100 percent of creditworthy accounts receivables.

Q: Are accounts-receivables-funding fees tax deductible?

A: Most accountants agree that accounts-receivables-funding fees are a financing expense that should be treated as such.

Q: Does the factor purchase outstanding invoices?

A: Yes. For the first funding only, factors may purchase some invoices that are no more than 30 days old. Exceptions can occur for certain situations.

Q: Does the factoring company verify invoices?

A: Verifying the legitimacy of invoices is an essential and accepted part of factoring. Occasionally, during the verifying process, factors will discover a problem with an invoice, either in the customer’s ability to pay, the delivered product or the service rendered. The factor can tell clients if there is a problem right away. As a company begins to factor its invoices, the company often should inform its customers that it is working with a factor.

Q: What happens if a customer doesn’t pay the invoice?

A: This depends on whether a company entered into a nonrecourse or recourse agreement with the factor. In a nonrecourse agreement, factors will absorb the credit-related loss. With a recourse agreement, a company will be required to reimburse the factor either by having the invoice deducted from the advance or replacing it with another, collectable invoice.

Q: How can a business be certain that a factoring company and its affiliate will treat its customers well?

A: The last thing a factor wants to do is cause businesses to lose customers. Factoring companies are not collection agencies. Maintaining customers’ goodwill and confidence is of utmost importance to factors. Many companies are aware that factoring is a common source of financing and know that the quality of a business’s service will not be hampered by its decision to factor.

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Quick and easy financing is one trademark of factoring. Today, many companies have some cash-flow concerns. Factoring can free a business from the endless cycle of invoicing and waiting to collect outstanding payments and make cash flow more predictable.


 


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