Getting an Advance on Your Accounts Receivable

When you have decided to establish a factoring relationship to bolster your company's cash flow, you will not initially get the full amount of the invoice. You get an ADVANCE of the face amount of the invoice. The remaining amount, referred to as the reserve, is held back until the invoice is paid by the customer. The industry standard is to hold back a 20% reserve, but can be more or less depending on the type of industry, make-up of the company's customers, and other factors.

When an invoice factoring company promises a 97% advance rate, either you or your attorney should read the contract very carefully. Make sure you know what you're getting into.

Kent Harlan, CPA
Ozarks Capital Funding, LLC
www.ocflink.com
kenth@ocflink.com
417.849-7394

When you submit an invoice for factoring, funds get wired into your bank account for use to grow your business. But with invoice financing you do not get the full amount right away. You get an ADVANCE of the face value of the invoice. The industry standard in commercial financing is 80 % of the invoice is funded as the advance, while the 20 % is held back in RESERVE until the invoice has been paid by the customer. Once the invoice gets paid the fees are deducted from the reserve and the remainder is forwarded on to you.

While factoring companies normally advance 80 % of the invoice, sometimes the advance is lower (60 – 70%) due to issues associated with certain industries. Other accounts receivable finance companies do provide a higher percentage advance, but check the fine print because the great majority of factoring companies, like ours, have been utilizing the 80% advance for years because it is statistically to most secure method.

Invoice Factoring Companies for Particular Industries

When you are searching for a factoring company, you should realize that some are more adept at providing a solution for your particular industry than others. Manufacturers, distributors, and service companies are all industries that can be served well by most competent factors. however, construction companies, healthcare providers, and transportation firms all have certain peculiarities that necessitate a niche factoring company. Construction has its own set of issues, particularly retainage. Healthcare billing is incredibly complex due to Medicare and Medicaid, discounts from the insurance companies, and coding errors. Because of these issues, a factor than knows this industry very well is essential. Trucking companies are effected by a host of government regulations, bills of lading, and owner-operators.

Make sure that the factoring company finances invoices in your industry on a regular basis.

Kent Harlan, CPA
Ozarks Capital Funding, LLC
www.ocflink.com
kenth@ocflink.com
(417) 849-7394

How Bonding Impacts Factoring Relationships

When a company is providing goods or services to a government agency, they may be required to post a performance bond that is issued by a surety company. This is part of the contract and the purpose of this type of bond is to insure that labor and materials connected with the job are paid for. This type of situation can affect the factoring relationship in that the bonding company will have a position in the assets in the company. In fact, the position will supersede that of the factoring company. You might think this would kill the deal, but it usually doesn't. The bond issuer and the factoring company need to get their agreements in place to allow for invoice factoring. This isn't especially time consuming IF all parties understand the bonding situation from the beginning. If it comes up during the factor's due diligence review, it could slow the process down considerably.

Kent Harlan, CPA
Ozarks Capital Funding, LLC
www.ocflink.com
kenth@ocflink.com
(417) 849-7394





There are occasions where a company looking for accounts receivable factoring is working for a city or government agency that requires a payment or performance bond from a surety company. The bond is part of the contract that insures that labor and materials will be paid for the job. Primarily in construction related situations but it can crop up in any municipal contract. The factoring company needs to know about any bonding that you have in place. The bond issuer has a position on the assets of the company that supersedes the factoring arrangement. So the factoring company and the issuer need to get their agreements in place to allow for the invoice financing. It is usually not a problem but could eat up some time to pull together, letting everyone know right away if there is a bond will speed up the factoring process.

What Factoring Can and Cannot Do

Factoring companies advance cash to companies that have a legitimate pool of business to business accounts receivable. The product or service sold must have already been completely performed, accepted by the customer as satisfactory, and invoiced to them. Until the customer agrees that the invoice is acceptable and will be paid, the factoring company cannot advance funds on it.

Invoice factoring is a great way to enhance and strengthen a firm's working capital position. But it needs to be understood what this type of financing cannot accomplish:

• Factors won't advance funds on future services or products to be shipped in the future.
• Start-up capital for a company with a new contract that needs funds for production. This type of situation would likely need purchase order funding.
• The factoring relationship can't finance equipment, inventory, or real estate. Funds derived from advances can be used for any purpose, but factors don't provide direct financing for those assets.
• Sales professionals can't use factoring to receive advances on commissions.
  

Factoring is an Off-Balance Sheet Transaction

Invoice factoring is not a loan. It is the purchase of a company's accounts receivables at a discount. As a result, advances made to the company from a factor are not classified as a liability on the balance sheet. The financial goal to keep debt to a minimum is therefore maintained. Once the customer pays the factoring company, the transaction is complete. Compare that scenario with receiving a line of credit with the bank in which frequent pay downs aren't required. The credit line will likely transition to a term loan, which does not help the appearance of the balance sheet.

As we've discussed before, funding from accounts receivable factoring is only limited by the company's pool of their accounts receivable. Because of this, a fast-growing company can get all the working capital it needs to expand.

How Invoice Factoring Companies Receive Payments

At the inception of an invoice factoring arrangement, a notification letter is sent out to all the customers asking them to forward payments to the factor. The notification letter is typically written in such a way as to emphasize that the receivables for XZY Corp. are being managed by a third party (the factor) and that the same great relationship with them will continue. Since the receivables are the "collateral" for the cash advances the company has received, it is necessary for the factoring company to have control over payments.

Occassionally, there will still be payments sent to the company. It is imperative that the company receiving the factoring services immediately forward on those payments to the factor. To knowingly deposit those funds into the company bank account would be, at the least, an action that would cause a termination of the funding arrangement. In some cases, company officials could be prosecuted for a crime.

Kent Harlan, CPA
kenth@ocflink.com
www.ocflink.com
(417) 849-7394

Recourse and Non-Recourse Invoice Factoring

When you are working to establish an accounts receivable factoring relationship, you should understand the details of the contract. In particular, you need to know the difference between recourse and non-recourse factors.

With a recourse factoring arrangement, you are required to replace a bad debt with a new receivable of a like amount (or refund the advance back to the factoring company). With a non-recourse facility, that requirement is not made unless it is determined that either the services or products weren't received by the customer or fraud was involved. When reviewing proposals, it is very important to keep these factors in mind.

Accounts Receivable Factoring - A Case Study

You read a lot about various alternative financial products, but which ones really work? Invoice factoring is a great way to acquire working capital for those that companies that carry receivables and can't get the funds they need from the bank. One such company was a boat trailer manufacturing company in the Midwest. They were growing rapidly and exhausted their bank credit line. With pending orders unfilled due to a lack of working capital, I worked with the owner to establish a factoring arrangement. Within two weeks, the company had the funds they needed to produce the orders. Since funding is only limited by the company's pool of receivables, they were able to accelerate their growth beyond their wildest dreams.

Why Use a Broker for an Invoice Factoring Transaction?

When a company has not been able to achieve the financing it needs from a bank, alternative methods like accounts receivable factoring are available. Should you just type in "factoring" in the Google search box and call the first few companies that show up on the list? Just because a factoring company has achieved a high organic ranking on Google doesn't necessarily mean that they will be a good fit for your firm.

By utilizing the services of a competent business finance broker, you can be steered in the right direction. Competition among factoring companies is fierce. Many have specialized niches. One may be more adept at working with trucking companies while another may be more suited for manufacturing. A broker who knows the factoring industry will know which company is most likely to serve your needs. Using a broker will not cost you any more money, as commissions are paid by the factor. On the contrary, you will actually save money and time.

Kent Harlan, CPA
Ozarks Capital Funding, LLC
www.ocflink.com
(417) 849-7394

Why Don't More Companies Factor Their Inivoices?

Although factoring volume has grown every year since 1984 and is a favorite financing tool in several industries. many companies don't take advantage of it. Many people have the misguided belief that factoring fees are in same range that loan sharks charge. There was a time (several decades ago) when factors took advantage of companies in bad financial shape and had nowhere else to turn. Those days are over. With the increase in competition among factoring companies, rates are still higher than bank financing, but affordable. If a company has a reasonably healthy profit margin, invoice factoring should be considered if a bank turn down has occurred.

Factoring can be beneficial for most any industry that carries business to business receivables. Manufacturers, distributors, and service providers are all industries that can free up working capital now rather than wait 30 to 60 days and beyond to get paid by their customers.

Kent Harlan, CPA
www.ocflink.com
(417) 849-7394

Factoring Invoices in a Slowing Economy

When your company is being negatively impacted by a slowing economy, you might consider using accounts receivable factoring as a financial resource. It is important to perform an analysis of your current financial health to see if you're a candidate for factoring. One way to do that is to calculate a Z-score. This analysis was developed in the 1960's by a statistician named Edward Altman. The Z-score is a combination of various financial statement ratios taken from both the balance sheet and income statement. The formula is as follows:

Ratio Weighted Average
1. EBIT/Total Assets 3.3
2. Net Sales/Total Assets .999
3. Equity Mkt. value/Total liabilities .60
4. Working Capital/Total Assets 1.2
5. Retained Earnings/Total Assets 1.4

The model asserts the following:

A Score over 3: reflects a company on solid footing
Between 2.7 and 2.99: The factoring company should exercise caution and require increased monitoring.
Between 1.8 and 2.7: There is a good chance of the company going bankrupt within 2 years.
Less than 1.8: 94% chance that the company will need to file bankruptcy within the next year.

The Z-score is widely used as a barometer of financial health and a predictor of bankruptcy in the short term. Other fundamental methods should be used in conjunction with the Z-score such as financial trend analysis of revenues, expenses, and profits. In addition, there may be internal and external factors that could change the ratios in the future such as new product roll-outs, mergers, and new competitors in the industry.

www.ocflnk.com
phone: (417) 849-7394

Are You a Candidate for Factoring?

Invoice factoring can be a valuable way to move your business forward and provide the working capital you need. You are putting one of your most valuable assets, accounts receivable, to work for you.

Although entering into a factoring arrangement is much simpler and less time-consuming than applying for a bank loan, you still would like to know up front if you're a good fit before the process begins.

Here are some of the questions that need to be answered in the screening process:

• Is your company's profit margin enough to cover the fees? As we've discussed before, factoring is not cheap financing, so it's important to have a decent profit margin to make it worthwhile.
• How much do you invoice each month? If you plan to factor less than $10,000 per month, your choice of funding companies will be limited. You should disclose your level of volume up front before you start the application process.
• Are you sure your receivables aren't currently being used as collatoral? A factoring company will insist upon having a first position on your receivables, so you should determine if your existing lenders haven't filed a UCC on your A/R. Don't be alarmed if the receivables pledged. Banks are often cooperative with factors.
• Do you do business with only one company? Factoring companies may have a concentration issue of you only have one customer. In that scenario, their risk is magnified because if something happens to that customer, they don't have other receivables to fall back on. It will help if the customer is large and stable.
• Does your accounting system generate aged receivable reports? 'This is critical, as factors depend upon accurate and timely aged receivable reports to determine if your company is a viable candidate.

Kent Harlan, CPA
Ozarks Capital Funding, LLC
www.ocflink.com
(417) 849-7394

When you See Low Factoring Fees Advertised, Be Wary

Look at any pay per click ad on Google or other search engines, and you'll likely see something like "factoring rates as low as 1% per month". Sound too good to be true? It probably is. Before you can't wait to submit your invoices to a company that advertises these "incredibly low rates", make sure either you or attorney review the contract very carefully.

First of all, the 1% may mean for the first thirty days only. You'll want to see what the rate will be for days 31-90. Chances are, those teaser rates that got you hooked will escalate dramatically.

There are often other charges buried in the contract you should be wary of:

• per invoice charges
• application fees
• administration charges
• renewal fees

In addition, you should determine exactly when the reserves will be released and ask if the invoices are bulk assigned. When comparing factoring companies, you should analyze all of these charges.

Click here for more information on OCF programs or to request a free quote or call (417) 849-7394.

Invioice Factoring for Long-Term Services

Can invoice factoring be utilized if the service provided spans a long time frame?

The answer is yes, but the way the company bills the client is critical. When you initially set up the agreement with the customer, you should specify the exact work to be performed as it relates to billing. In other words, both parties should agree that an invoice can be generated upon a certain level of performance, or milestone. The factoring company will be able to advance funds based upon that invoice even though the entire job isn't completed.

Contrast this scenario to progress billings, an arrangement in which the customer advances money for the job as a whole. The factor is hesitant to advance funds to the client with progress billings, since the company getting billed may become unhappy along the way and stop making payments. With milestones, on the other hand, that is not a problem.

How a Company can Improve its Gross Margin with Factoring

"If I'm to pay a 3% factoring fee, and my profit margin is only 3%, how can my company benefit?
A company making only a 3% net profit margin can do more business volume as a result of invoice factoring, and the larger volume will result in a higher profit margin because fixed costs do not increase with volume. The added business at a higher marginal profit leads to an increased overall profit margin. As the volume increases, the cost of production decreases, so that profits increase. Fixed costs such as rent, trash expense, and administrative salaries generally don't increase with a volume rise. Utilities, telephone, and workmen's compensation insurance are expenses that will rise slightly, but not nearly as much as production costs do. Therefore, a company utilizing accounts receivable factoring can increase its volume and profit level.
kenth@ocflink.com
www.ocflink.com

Isn't Factoring Too Expensive?

I get this comment all the time: "Factoring is expensive compared to traditional bank lines". If you can get financing from the local bank that satisfies your needs, then do it. Unfortunately, not everyone can get a bank line of credit to fuel the growth of their company or bail them out of a financial hardship. If you're growing at an accelerated pace, the bank may not be able to keep up with your cash needs. If you're in trouble, the bank probably won't cooperate.

Invoice factoring is a way to get the cash you need when you need it. When deciding whether or not to factor your invoices, you should evaluate the incremental profits derived from taking advantage of this financing tool.

How are Factoring Fees Determined?

Invoice factoring fees can vary between 2 1/2% and upwards of 4 1/2% per month, depending on several variables. The difference can result in fee expenses of thousands of dollars to the average factoring client. The type of receivables you choose to factor and the companies you sell to are important in the overall rate that is charged.

Factoring companies place a great deal of importance on the credit standing of your customers. If Walmart is one of your customers, underwriting will look very favorably on funding those invoices (even though they are habitually slow payers). On the other hand, a company that is financially shady will cause the rate to go up.

Other factors that are involved in determining fees are total volume per month, average amount of invoice, and number of invoices to be factored each month. It might behoove you to not factor those invoices that are to poor credit risk companies or those that are comprised of several small invoices each month.

How Receivables Factoring Can Benefit Your Company

In many financial circles, the "f" word is not to be used. However, factoring is a well-established form of business financing that produces immediate cash payments to a company at the time of shipment, delivery and invoicing a customer. In its basic form, factoring has been used by American business since Colonial times, and its origins go back even further, literally thousands of years to the early days of commerce. Factoring has a bad name among some "experts" because of what is perceived as an excessively high cost of capital. But those who are able to put things in perspective know that when bank financing isn't available, other alternatives should be at least reviewed for viability. For example, lets say you have the opportunity to execute a new contract, but you need capital for production costs and overhead. Your friendly banker says he'd like to help, but your company is overextended. What do you do?

An analysis of how the costs of the contract could be funded by factoring should be performed. Will factoring provide enough working capital to pay the additional labor and overhead? If so, will the fees be covered to provide an adequate amount of profit?

Sadly, many business owners give up after a bank turn down rather than seek alternative forms of financing. The prudent thing to do is to take a few minutes and fill out an application for a factoring arrangement. The factor will know if your company is a good fit for this type of financing.

What is invoice factoring?

Put simply, invoice factoring is the sale and purchase of a company's accounts receivable at a discount. The transaction occurs between a company with existing accounts receivable on its books and a firm known as a "factor". The factor advances a percentage of the invoices submitted (usually between 75%-90%) in cash usually right after the invoice has been created. The difference between the face amount of the invoice and the amount advanced is called the reserve. Upon collection of the invoice, the reserve less the factoring fee is remitted to the client.

Factoring is designed for companies that have cash flow issues. Typically, firms with cash flow problems fall into two camps: those that have sustained significant losses and are having trouble paying current obligations like payroll and operating expenses, and those who are growing at a very rapid clip.

If a company wants to start factoring, they must fill out, sign and submit an application. In our next post, we will discuss the application process.