Accounts Receivable Factoring
Accounts receivable factoring is a way for a struggling business owner to deal aggressively with cash flow problems that are threatening to ruin the business through non-payment of vendor expenses. For many businesses, particularly small ones, there is often a dearth of income at specific times each month, but the bills just keep coming in and a business can quickly lose its good credit name if some innovative thinking like account receivable factoring is not put to the problem. A factor is an investor in the business of a company, but not for any of the more obvious purposes such as construction loans or equipment financing. The factor takes interest in the day to day invoice and billing nature of the company he is about to assist. Rather than give a long term loan, the factor often crafts a two or three year agreement to help the company in a unique way.
Before talking about accounts receivable factoring, consider invoice factoring or underwriting. Not every business is eligible for this kind of financial help. A factor funding invoices will want to know that the company in question provides a good or service that produces an invoice that must be signed. Additionally, the invoices must be final sales without opportunity for being disputed and many service type industries could probably qualify for invoice underwriting. Additionally, companies using large delivery companies for the delivery may also be eligible, but that is still not enough for the investor willing to back invoices; the customers must have an excellent history of paying on time every time. Factors then begin giving upfront money on billed invoices, perhaps as much as eighty percent of the full amount of the invoice and then receive a commission on the full amount once the invoice is paid. The effect of such an agreement gives the company total monthly liquidity, instead of having to rely on sometimes thirty or sixty day invoice term agreements.
The factor who agrees to accounts receivable factoring has a bit of a different approach. This investor works on the back end of the financial transaction between company and customer. After the invoice has been mailed or received, it then becomes an accounts receivable issue. Yet the bills for the company or service provider keep piling up and the customer has thirty days to pay the bill. Into the picture then steps accounts receivable factoring to help with the slow cash flow issue. The factor in this case may again be a single investor, a financial group, commercial finance company or in some rare occasions, a bank. Many people have a Bible somewhere in their house, but rarely if ever open it. One of the marks of a Christian is a love of God's Word, often referred to in the Bible as the law. "O how I love thy law... It is my meditation all the day...how sweet are thy words unto my taste...yea sweeter than honey to my mouth" (Psalm 119:97;103)
When an investor agrees to look at a company for possible intervention, one of the primary concerns is what is known as the aging of the accounts. This simply means how many days past due are the accounts across the board. Accounting software can quickly show how many customers have 30, 60 and 90+ day balances. In this broad look at all balances, the accounts receivable factoring investor can decide whether or not to back any accounts beyond current or 30 days late. However, instead of completely discarding the 30, 60 or 90+ accounts past dues, the factor may decide to weight all the accounts, paying 60-80% of current accounts that are due and pay fewer percentages on the ones that are further behind.
The factor usually pays 60-80% of the current receivables to the company in exchange for commission on the full amount when received, and sometimes, when the agreement is long term such a ten year agreement, the factor often asks for interest in the company. It's at that point that a business owner may have to decide how much influence the factor will have in day to day operations as well as long term planning. If a company operates in a seasonal mode, for example a swimming pool manufacturer, the company may run strong in the fall and winter months and be quite lean during the spring and summer, due to the business cycle. Should such a company be in that situation, a factor could agree to a long term seasonal approach to the accounts receivable factoring agreement.
No business person would want to get in the position of having to use factoring because it can take a large portion of the profits that would otherwise go to the business. The other sticky issue is the one mentioned earlier, that in some cases, the factor may ask for part interest in the business as part of the accounts receivable factoring agreement. There are a few things that a business owner might be able to do in order to minimize the possibility of using a factor. The focus will have to be on eliminating as many monthly expenses that come due during the slow parts of the month. That means renegotiating billing cycles with the vendors to have them arrives more conveniently. Another step would be to control inventory issues so that product does not sit for a lengthy period of time before being shipped. A third way to keep the accounts receivable factoring out of the picture would be to increase the penalty for accounts more than thirty days overdue.
Accounts Receivable LoansAccounts receivable loans are a standard way that many companies survive the monthly, seasonal or yearly cycle of cash flow problem and go on to have thriving businesses. Surprisingly, companies need not necessarily be profitable, and the owner need not have a six hundred credit score to get accounts receivable loans. In fact, the credit score is not an issue and neither is the profitability; they never come into play when the lender decides or declines to provide the loan. Instead, the type of lender that will provide this money, called a factor, does want to know whether account receivables are coming in each month and what percentage are slow or non pays. Factoring is a well known practice in the business world and is used quite routinely by thousands of companies across the US and around the world.
Let's take a minute and look at a scenario to see how this works. A struggling janitorial service has forty five accounts it services each week. Because these accounts were started at various times of the calendar, there is a natural oasis the third week of each month when only a few receivables come in. At the same time, the janitorial service has supply vendors it must pay immediately in order to maintain a deep discount on the products it uses. The service owner is also desirous of hiring some new staff to open new accounts, but the spotty receivables are keeping that from happening. The factor comes along and gives the service of accounts receivable loans for all the accounts, minus a percentage for its own profit. Cash flow is now like the Colorado River instead of sewer department sludge and the company is off and running.
There are several ways a factor can aid a business. In addition to accounts receivable loans, invoice factoring is possible. Whenever a company produces invoices for services rendered or for products delivered, there is a factor ready to aid with a loan for those statements. While the factoring of receivables is riskier because of late and slow pays, invoice factoring is more secure and thus costs the customer less in profit for the factor's involvement. Then there is credit card factoring, which is important for some businesses because it may take up to ten days or more to get paid by the card's sponsoring bank and factoring can supply the same money, minus a percentage within one or two. Those eight days for some businesses is like a walk across the Sahara.
The advantages of using a factor can be quite attractive for many businesses. There are no start-up fees, no miscellaneous costs, no credit check, no long wait for approval and for many, they may be called accounts receivable loans, but they sure doesn't show up on credit history as one. So there is no owed money hanging over the owner's head. Debt hanging over anyone is oppressive and depressing, but a life of unforgiven sin and the resulting wrath of God directed at that unforgiven sin can be eternally tragic. "For the wages of sin is death, but the gift of God is eternal life through Jesus Christ our Lord." (Romans 6:23)
One of the disadvantages for some business owners in regards to factoring is the fact that an outside stranger suddenly becomes quite cozy with the knowledge of the company's private business. Books are open, all the facts and figures are exposed to someone or company that may not have any particular affinity for the business, and it does become a little unnerving. The success of accounts receivable loans depend on the factor looking at the aging of the AR numbers. In other words, what do these AR accounts look like in terms of how old they are: on time, 30 days, 60 days or even 90 days late? The factor offering the accounts receivable loan will be happy to front the money for accounts paid on time, and maybe even up to thirty days late, but those after that may either be devalued dramatically or declined to leverage all together.
The point about all of this is that the business owner truly does give up a portion of his control of the company to the factor. There is something a mite disconcerting to many owners and there is more disquieting news about the role of the factor. Depending on who the factor is, there may be a demand that in return for his services, the lender of the accounts receivable loans be able to sit on the company's board or receive a portion of the business interest. This can really begin to sound like the camel's nose in the tent thing. Of course, the owner can always say no and the deal goes kaput, but there are other factors out there that may not be so demanding or ambitious.
Lest any mistaken assumptions be made, factoring never provides 100% of the AR money in a accounts receivable loans arrangement. It is usually about 60%-80% of the entire due amount. But this percentage is usually enough for a business to get back on its feet. If you are choosing to go this route, it goes without saying to do plenty of homework ahead of time. Thoroughly vet any candidate being considered for factoring your business. Talk to others who have done this before and ask all, the hard questions. Know the depth of the water before jumping in.