For a lot of businesses, the invoice factoring company takes up the job of your firm’s ” investor,” delivering instant cash as required. It does not take very long, however, before companies use the other resources most factors have to offer. Most full-service factoring companies can take the place of your collections department and eliminate some of the costs and problems that come with late payments, bad checks, credit checks and bad debts.
This element of the invoice factoring process appeals to many firm owners because it liberates accounting staff from the laborious duties of issuing overdue payment notices and carrying out credit checks. Also, with a factoring company checking into the creditworthiness of your clients, you can sleep easy during the night, never ever asking oneself if a very much required check will come in tomorrow’s mail.
Aside from the clear advantages to your accounting department, factors Factoring Company will frequently furnish cash advances on purchase orders, giving you cash in hand before the order is even complete. Purchase order financing helps those who have the purchase orders, but are without the resources needed to complete the orders.
It’s obvious that factoring fees will be greater than loan interest required by a clicking here bank. Nevertheless remember that you cannot actually compare invoice discounting (a short-term debt instrument) with a bank loan (a long-term note) due to the fact that they are two totally different forms of financing.
The key to figuring out if you can afford to factor is not to look merely at the underlying cost, but to also consider how your company could boost its earnings through invoice discounting. Consider unearned income and forfeited business opportunities a result of your scarcity of cash flow. At the same time, consider the financial savings you could well experience with factoring. You can cut out late payment charges and make use of early payment or quantity purchasing reduced rates. And also, think of whether factoring will help you to scale down your accounting team by lowering the quantity of overtime used on collections and credit checks.
It is rare that companies make a decision not to factor because they could not afford to. In reality, in many cases, firms determine to factor because they simply cannot afford NOT to.
Compared with a bank loan, the receivable factoring company authorization approach can take short of a week. The key to a speedy approved process is a thorough and precise client profile. You can save the receivable factoring company hours, even days, when you are forthright and hones about the data sought. You should give details about your customers and the aging of their accounts. Aside from a client profile, you may have to supply specifics pertaining to your company for example, a list of the customers, length of time in business, monthly sales volume, and a description of your operation.
After okayed, you can expect to negotiate terms and conditions with the factor. The arrangement process takes many features of the deal into factor to consider. Say, if you desire to factor $10,000, you just cannot look for as great a deal as a firm who plans to factor $500,000.
Through the negotiation process, you will become aware of what it costs to factor your accounts receivable. Depending on the discount schedule you work out, a factor accountsreceivablefinance.org may hold on to between 2-10 percent of the invoice’s face value as a cost. Although, when evaluated against the cost of forfeited business or losing you business entirely, the significance of the fee related to factoring lessens greatly.
Immediately after you reach an agreement with the factor, the finance tires commence to roll. The factoring company conducts due diligence by investigating your customers’ credit and any liens put against your company. The factor also confirms the authenticity of your invoice in advance of investing in your receivables and advancing money to you.
Unlike what most small business owners believe, funding a business is not brain surgery. In point of fact, there are only three major ways to do it: via debt, equity or what I call “do it yourself” finance.
Every technique comes with benefits and drawbacks you should be aware of. At various stages in your business’s life cycle, one or more of these methods may be appropriate. For that reason, a complete understanding of each method is essential if you think you may ever have to secure funding for your business.
Debt and Equity: Pros and Cons
Debt and equity are what many people think about when you ask them about business financing. Traditional debt financing is typically provided by banks, which loan money that must be repaid with interest within a certain period. These loans typically must be secured by collateral in case they can not be repaid.
The cost of debt is relatively low, especially in today’s low-interest-rate setting. However, business loans have become more challenging to come by in the current tight credit environment.
Equity financing is provided by investors who receive shares of ownership in the company, as opposed to interest, in exchange for their money. These are typically venture capitalists, private equity firms and angel investors. Even though equity financing does not need to be repaid like a bank loan does, the cost over time might be much higher than debt.
This is because each share of ownership you divest to an investor is an ownership share out of your pocket that has an unknown future value. Equity investors often place terms and conditions on funding that can handcuff owners, and they count on a very high rate of return on the companies they invest in.
My preferred kind of financing is the do-it-yourself, or DIY, variety. And one of the best ways to DIY is by using a financing technique called invoice discounting. With factoring products, companies sell their outstanding receivables to a commercial finance company (sometimes referred to as a ” invoice factoring company”) at a discount. There are two key advantages of factoring:.
Significantly improved cash flow Instead of standing by to get payment, the business gets most of the accounts receivable when the invoice is produced. This reduction in the receivables delay can mean the difference between success and failure for companies operating on long cash flow cycles.
Say goodbye credit analysis, risk or collections The finance company performs credit checks on customers and evaluates credit reports to uncover bad risks and set appropriate credit limits essentially becoming the businesss full-time credit manager. It also performs all the services of a full-fledged accounts receivable (A/R) department, including folding, stuffing, mailing and documenting invoices and payments in an accounting system.
Invoice Factoring is not as widely known as debt and equity, but it’s often more useful as a business financing instrument. One reason many owners don’t consider factoring first is because it takes a while and energy to make invoice discounting work. Many people today are looking for immediate answers and immediate results, but stopgaps are not always offered or advisable.
Making It Work.
For factoring to work, the business must accomplish one very important thing: deliver a top-notch product or service to a creditworthy customer. Undoubtedly, this is something the business was created to accomplish to begin with, but it serves as a built-in incentive so the business owner does not forget what he or she should be doing anyway.
Once the customer is satisfied, the business will be paid immediately by the factor it doesn’t have to wait 30, 60 or 90 days or longer to get payment. The business can then immediately pay its suppliers and reinvest the profits back into the company. It can use these profits to pay any past-due items, obtain discounts from suppliers or increase sales. These benefits will typically more than offset the fees paid to the invoice factoring company.
By factoring, a business can grow http://www.accountsreceivablefinance.org its sales, develop strong supplier relationships and enhance its financial statements. And by relying upon the factoring company’s A/R management programs, the business owner can concentrate on expanding sales and increasing profitability. All of this can take place without increasing debt or diluting equity.
The average business factors for about 18 months, which is the period of time it usually takes to attain growth objectives, pay off past-due amounts and boost the balance sheet. Then the business will likely find themselves in a better position to search for debt and equity opportunities if it still has to.
There are countless misperceptions amongst CFOs and finance executives when it involves asset-based lending. The greatest is that asset-based lending is a financing choice of last resort – one that only ” hopeless” companies that can’t qualify for a traditional bank loan or line of credit would look into.
With the economic slump and resulting credit crunch of the past few years, though, many companies that might have gotten more traditional forms of bank financing previously have instead gone to asset-based lending. And to their shock, many have found asset-based lending to be a flexible and cost-effective financing resource.
What Asset-Based Lending Looks Like
A common asset-based lending situation frequently looks something similar to this: A business has gotten through the recession and financial crisis by aggressively managing receivables and inventory and postponing replacement capital expenditures. Since the economy is in recovery (albeit a weak one), it will need to build up working capital so as to fund new receivables and inventory and fill new orders.
Unfortunately, the business no longer qualifies for traditional bank loans or lines of credit due to high leverage, weakening collateral and/or extreme losses. From the bank’s perspective, the business is no longer creditworthy.
Even businesses with durable bank relationships can run afoul of loan covenants if they experience short-term losses, at times forcing banks to pull the plug on credit lines or drop credit line increases. A couple of bad quarters doesn’t always indicate that a business finds themselves in trouble, but occasionally bankers’ hands are tied and they’re forced to make financing choices they might not have a few years ago, before the credit crunch changed the rules.
In instances like this, asset-based lending can deliver much-needed cash to enable businesses weather the storm. Companies with good accounts receivable and a sound base of creditworthy customers often tend to be the very best candidates for factoring advances.
With conventional bank loans, the banker is primarily concerned with the borrower’s predicted cash flow, which will provide the funds to repay the loan. Therefore, bankers pay particularly close attention to the borrower’s balance sheet and income statement so as to evaluate future cash flow. Asset-based lenders, conversely, are primarily concerned with the performance of the assets being pledged as collateral, be they machinery, inventory or accounts receivable.
So prior to lending, asset-based lenders will normally have machinery or equipment independently valued by an appraiser. For inventory-backed loans, they typically require regular reports on inventory levels, in addition to liquidation valuations of the raw and finished inventory. And for loans supported by accounts receivable, they usually perform in-depth analyses of the eligibility of the collateral based on past due, concentrations and quality of the debtor base. But unlike banks, they often do not place tenuous financial covenants on loans (e.g., a maximum debt-to-EBITDA ratio).
Asset-Based Lending: The Nuts and Bolts
Asset-based lending is in fact an umbrella term that covers several different kinds of loans that are secured by the assets of the borrower. The two primary types of asset-based loans are factoring and accounts receivable (A/R) financing.
Factoring is the outright purchase of a business’ outstanding accounts receivable by a commercial finance company (or factor). Typically, the factor will advance the business between 70 and 90 percent of the value of the receivable at the time of purchase; the balance, less the factoring fee, is released when the invoice is collected. The invoice factoring fee typically ranges from 1.5-3 .0 percent, relying on such factors as the collection risk and the amount of days the funds are in use.
Under a contract, the business can usually pick which invoices to sell to the factor. The moment it purchases an invoice, the factoring company handles the receivable until it is paid. The factor will practically become the business’ defacto credit manager and A/R department, ” completing credit checks, analyzing credit reports, and mailing and documenting invoices and payments.”.
A/R financing, meanwhile, is similar to a standard bank loan, but with some key differences. Although bank loans may be secured by different kinds of collateral including equipment, real estate and/or the personal assets of the business owner, A/R financing is backed purely by a pledge of the business’ outstanding accounts receivable.
Under an A/R financing arrangement, a borrowing base is created at each draw, against which the business can borrow. A collateral management fee is charged against the outstanding amount, and when funds are advanced, interest is assessed only on the amount of money actually borrowed.
An invoice generally must be less than 90 days old to count toward the borrowing base. There are often other eligibility covenants such as cross-aged, concentration limits on any one customer, and government or international customers, depending upon the lender. In many cases, the underlying business (i.e., the end customer) must be regarded as creditworthy by the finance company if this customer makes up a majority of the collateral