1st Trust Factoring | Factoring Questions and Answers

Frequently Asked Questions and Answers

What is accounts receivables factoring?
Why should I use a cash flow consultant rather than going directly myself to a factoring company?
What are the major benefits of factoring?
How can you improve your balance sheet with factoring - i.e. show more profit?
Why should I use factoring instead of a bank line of credit?
Is there a downside to selling my accounts receivables?
What is recourse factoring vs. non-recourse factoring?
What is the process to get factoring funds?
How much money can I get?

For purposes of explanations below, the following definitions apply:

Factor is the financing company which would buy the client's receivables.
Client is the company wanting to sell its receivables.
Customer owes money to the client for payment of an invoice.

Q: What is accounts receivables factoring?

Factoring is a very old method of business financing. Its history goes back to the days of money lenders in Europe in the middle ages. Recently, it has become one of the most popular methods of financing for businesses in the United States.

In short, factoring is the sale of a company's accounts receivable to a factoring finance company, also known as an invoice factoring company. Instead of having to wait for your customers to pay you, you generate immediate cash flow as soon as you issue an invoice, based on your customers' credit record and ability to pay, not your own business credit record. This is an alternative form of financing as opposed to obtaining a loan or line of credit from a bank. Factoring is not a loan, it is the sale of an asset - a company's accounts receivables. A loan places a debt on a balance sheet, while factoring puts money in the bank, cash (improving the balance sheet), without creating an obligation to pay money back to the bank. Because of the simple rules of the cost of money, a discount rate is charged on the receivables purchased. Most people don't realize that a common form of factoring today is the use of credit cards - merchants get their money right away for a discount.

Medical receivables factoring simply focuses on the healthcare industry, as there is more infrastructure required to process those invoices, and not all factoring companies handle medical receivables.

Q: Why should I use a cash flow consultant rather than going directly myself to a factoring company?

Simply put, there is way too much to know about this financing for the average business person to handle factoring directly through a factoring company and get an optimum solution for his/her cash flow needs.

For example - do you as the potential factoring client know and understand the answers to the following questions (a small part of what there is to know)?

Is an offer a factoring offer (buying your accounts receivable (A/R)) or is it an asset-based loan (a loan to you based on your A/R)?

If the offer is a factoring offer, is it recourse or non-recourse factoring?

Are you responsible for payment of all invoices even if your customers go out of business or declare bankruptcy? (And don't think that if customers are big companies, there is not a problem. What happened to MCI, and how about Enron, Montgomery Ward, Home Base, and a long list of other huge companies?).

Does the factor request that you factor all your invoices or factor only what you need? If your sales volume is $1,000,000 and you need to factor only $200,000 with a discount rate of 1.8%, will you be paying $18,000 in fees, which, in effect, is equivalent to a discount rate of 9% on the $200,000 that you really need.

Are there any other fees or charges, hidden or otherwise? Are there application fees, auditing fees, traveling fees, monthly flat fees, billing fees, reporting fees, handling fees, lock box fees, out-of-pocket expenses, etc…?

Are you required to factor a certain minimum volume per month, for which you will be charged whether you reach that minimum or not?

Are you required to have a factoring relationship for a certain term period (often a year) or are you free to terminate that relationship as soon as you do not need factoring anymore?

How fast does the factor fund you? Is it within 15 minutes to 48 hours or do they request all original invoices to be mailed and re-mailed, which might take several days? How fast do you usually need your cash?

Does the factor allow you to buy back any of the slow paying invoices to save substantial fees?

Does the factor allow invoice splitting? If your customer, for whatever reason, paid only $60,000 on a $100,000 invoice on day 30 and paid the balance of $40,000 on day 60, does the factor charge fees on $60,000 for only 30 days and on $40,000 for 60 days, or do they charge fees on $100,000 for the whole 60 days?

Does the factor do invoice batching? If you have a schedule of many small invoices, say 100 invoices of $500 each, would the factor close the schedule once they receive enough payments (say $37,000) to cover their advance and fees to that point, or would they wait until every single invoice is paid to close the schedule, which might take 60 to 90 days or more, thus charging you $4,000 to $6,000 or more in fees instead of $2,000?

Q: What are the major benefits of factoring?

Enables immediate access to cash and therefore easing of cash flow problems.
Provides working capital without adding debt to your balance sheet.
Allows a company to provide cash for growth to buy new materials, hire more staff, buy equipment, etc.
Evaluation of financial strength is for your third party insurers, not your own company.
Responsibility for chasing customers for payment becomes the factor's responsibility, not yours.
No predetermined maximum limit of funds which can be factored.
No collateral required other than the accounts receivables themselves.
Decreased reimbursement intervals between the time service is provided and payment is received.
Quick to set up - usually around 10 days to set up an account for initial funding and subsequent fundings happen within 1-7 days of submitting the invoices.
Business receives regular management reports on your invoices, enabling you to see what customers need more attention and perhaps where you should change your payment terms.

Q: How can you improve your balance sheet with factoring - i.e. show more profit?

The impact of factoring on the bottom line is the crowning argument of the cost benefit analysis. Although some benefits are less tangible than others (What price tag could be put on saving a business?), we can look at the quantified benefits enabling us to compare the bottom lines before and after factoring. The following is a classical comparison of a before and after factoring situation:

FINANCIAL BENEFIT OF FACTORING

	BEFORE FACTORING	AFTER FACTORING
Revenues	$100,000	$200,000
Cost of Goods/Services Sold	$65,000 (65%)	$130,000 (65%)
Gross Profit	$35,000 (35%)	$70,000 (35%)
Variable Costs	$10,000 (10%)	$20,000 (10%)
Fixed Costs	$20,000	$20,000
Cost of Factoring	N/A	$5,000
Net Profit	$5,000 (5%)	$25,000 (12.5%)

The above analysis is very simplified and used only for the purpose of demonstration where a company is growing or can sell more services with the addition of factoring to obtain cash needed to fund the expansion. The profit after factoring increased by $20,000 (from $5,000 to $25,000) by investing $5,000 in factoring cost. Thus the return on investment (R.O.I.) in factoring is:

R.O.I. = (20,000/5,000) x 100% = 400%

The obvious conclusion is: Benefits of factoring far exceed its cost.

A word of caution, however. The math for this calculation results in the following formula:

Gross profit (before factoring) - Variable Cost (before factoring) >= Factoring Cost

Therefore, a criterion of profitability to the client by factoring is that the difference between the gross profit and variable cost before factoring exceeds the cost of factoring.

Q: Why should I use factoring instead of a bank line of credit?

Factoring companies have more flexibility than banks.
Business factoring is easier to arrange than a bank loan.
Accounts receivable factoring can be implemented quickly and effectively. The initial setup may take one or two weeks, but after that, funds are available as soon as invoices are issued.
Factoring receivables is an effective solution to improving cash flow for a developing business.
For businesses that either cannot qualify for traditional debt financing or do not want to incur more debt, invoice factoring is a good alternative source of working capital.

Q: Is there a downside to selling my accounts receivables?

This is more of a tradeoff question. You gain the quick influx of cash and pay for it with a slight loss in the total accounts receivable collected over the long term. However, the ability to use the funds while otherwise waiting for payment from customers or insurance carriers places you in a position to better pursue improvements to your business or healthcare facility, be it additional personnel, increased advertising, taking advantage of cash discounts, improving your credit rating, etc. All these steps would be impossible without the cash realized from the factoring process.

Q: What is recourse factoring vs. non-recourse factoring?

Under traditional recourse factoring, a factor purchases the accounts receivables with recourse in case some accounts are never paid by the invoice customer. To cover this risk, a reserve is set aside at the beginning of each transaction, usually 15-20%, for any accounts that never get paid. If those accounts are paid, the appropriate reserve amount is returned to the client. In this case, the factor needs to be somewhat concerned with the financial stability of the client as well as the customer. Because there is recourse, discount rates are usually lower than rates for non-recourse factoring.

With traditional non-recourse factoring, factors usually do not keep a reserve or give rebates to clients whose customers pay early. In this case, the factor bears all the risk, except in cases of misrepresentation or poor services provided by the client. If a customer cannot pay his invoices, the factor most likely will not recover his losses. Consequently, discount rates are usually higher than rates for recourse factoring.

Q: What is the process to get factoring funds?

Processes vary by factor, but here is a basic list of events:

Initial contact with a cash flow representative to find your optimum solution

Review of company situation by cash flow consultant

Cash flow consultant recommends a potential factor and obtains required inputs from you

Factor reviews application

Factor performs due diligence to review documents and confirm funding amounts (required documents vary but generally include application, P/L statement, balance sheet, receivables aging reports, tax returns)

Upon completion of due diligence and approval, funds will be wired to your account from the factor

In general, this whole process can be completed in a three weeks or less, not several weeks as with a bank loan. Subsequent submittals, once approved, takes one to two days to obtain funding.

Q: How much money can I get?

A recourse factor will generally initially fund 70-90% of the requested funds, keeping a recourse fund with the remainder in case some customers do not pay their invoices.