The Right Tool for the Job

In our last post: “The Notification Issue”, we identified three general types of factoring relationships:

1. The factor buys all of the client’s accounts receivable and essentially takes over the client’s entire AR function. Some people refer to this as a traditional, full-line factoring relationship.

2. The factor buys all of the invoices due from one or more specified customers of the client. This is a hybrid sort of relationship that falls short of the full-line model but is more complete than the spot-factoring model.

3. The invoice-by-invoice purchasing, or “spot factoring” model. In this case there is no commitment by either party beyond the purchase and sale of the specified invoices.

In our last post, the distinction among these three general types of relationships was drawn in terms of the need to notify the client’s customer of the existence of the factoring transaction and to obtain acknowledgment of the transaction from the customer and an agreement to re-direct payment.

There are other important distinctions, though.

One of them is the expected duration of the relationship.

The full-line, traditional factoring relationship is intended to be a long-term, comprehensive solution to the client’s need. For whatever reason, the client will typically need not only a financing facility but also an accounting and a collections facility.

Setting up this kind of relationship requires time and investment on the part of both the factoring firm and its client and so there is usually a requirement that the client commit to:

a) a minimum duration of the relationship; a year or maybe two, and
b) a minimum volume of receivables sold to the factor; usually stated in terms of dollars per month.

Companies entering into this type of factoring relationship will usually be larger, well-established and stronger firms that could access other sources of financing if they chose to, but that find value in the full-line factoring model.

The second of our two general types of relationship—the hybrid—is also a longer-term, but less comprehensive, solution. In such a case the client might have one or more steady, sizable customers and a relatively permanent need to accelerate collections but might not have the ability to get traditional bank financing or to establish a full-line factoring relationship.

In the spot-factoring transaction the essence of the relationship is its short-term, use-it-as-needed nature. No commitments are typically required that either party—the factor or the client-- do any additional business with the other. That doesn’t mean that they WON’T do other business, it just means there’s no obligation.

This is in complete contrast with the traditional, full-line factoring relationship; where the factoring company knows it has a minimum amount of business for a stated minimum period of time. The spot factor might establish a relationship with a client; complete one transaction with that client; and never have any further business with that client.

The two extremes of our notification spectrum correspond to extremes of expected relationship length. And, as we’ll discuss in our next post, will also have very different pricing parameters.

The Interface Financial Group has been helping businesses with their cash flow needs since 1971. Solving cash flow problems is what we do.

The Notification Issue

There are three general structures used in receivables-factoring relationships:

1) the factoring company can buy all of its client’s receivables (and even take over the administration of the client’s entire AR process),

2) the factor can agree to buy all of the receivables of one or more specified customers of the client, or

3) the relationship can be on an invoice-by-invoice basis with the factor purchasing receivables only as and when the client needs the service. This third type of process is called “spot” factoring.

One of the important differences among the different types of factoring relationships is the extent to which the client’s customer must be notified of the sale of its invoice.

In the “full-service” sort of relationship described in #1, above, all of the client’s customers are typically instructed to re-direct all of their payments to a bank lock-box. The terms of the lock-box arrangement are such that customers don’t necessarily have to be told that their invoices are being sold to the factor. For some clients this kind of anonymity or administrative simplicity is important.

In the selected-customer sort of relationship described in #2, above, it is sometimes the case that a lock-box might be used and no specific notification of sale is required. Often, however, the arrangement requires a notification by the client to the customer that the client has established a financing relationship with the factor and that, from a given date, all of that customer’s payments must be sent to the factor or its bank.

The customer will usually be required to acknowledge that it will make the payments to the factor as directed and that it will not change the arrangement without the written consent of the factor.

In the spot factoring business, notification is a much more important and formal
process without which transactions cannot ordinarily be done.

The typical single-invoice Notification will have several elements:

a) the client notifies its customer that the invoice is being sold to the factor,

b) the client directs that payment be made directly to the factor,and

c) the client asks the customer to acknowledge that the goods/services have been provided; that they meet the contract specifications; that payment is due as shown in the invoice; and, that the customer will pay the factor directly.

This is typically known as “full notification”.

This process, obviously, requires much more effort on the part of all of the parties involved. It also gives the client’s customer more power (i.e. the power to refuse)in the process. When establishing a spot-factoring relationship, this is often the place where the process breaks down.

Without proper notification and acknowledgment, though, the factor cannot be sure that the invoice it is buying is valid and that, if it does buy it, it will be paid properly.

In a full-notification relationship, it is in the client’s best interest to discuss the notification requirement with its customer very early in the process. It can save everyone involved a great deal of time and trouble.

The Interface Financial Group has been helping businesses with their cash flow needs since 1971. Solving cash flow problems is what we do.

What a Factor Is NOT

It’s just as important to know what factor IS NOT and DOES NOT do, as it is to know when a factor can be just the right answer to your cash flow problem. A few key points:

1. A factor will not normally buy accounts owed by individuals.

Let’s say you are in the home renovation business and most of your customers are individual homeowners. That’s not normally going to work for a factor. The laws governing commercial transactions and those governing consumer transactions are quite different in many respects and the factoring business focuses on the commercial market.

So, if your customers are businesses, that works; but if they are individuals, it doesn’t.

2. A factor is not a debt-collection agency.

There ARE collection agencies, of course, and if you’re at the point with a receivable where all other avenues have failed; especially if the amount involved is too small to justify litigation; the collection agency might just be your answer. You’re probably going to get a small percentage of what’s owed and write off the balance. That’s NOT factoring.

The factoring company wants to buy receivables that are fully expected to be “paid-as-agreed”. It’s just that the business that is owed the money needs it sooner than “as-agreed”.

3. A factor doesn’t want to just look at your problem accounts.

Actually most factors will not consider purchasing receivables that are over-due by more than a certain number of days. The factor doesn’t want to buy problem accounts/invoices. The principal problem the factor is in business to solve for a client is it's need to accelerate cash receipts. (There ARE factoring companies that will essentially take over a client's entire accounts-receivable operation; but those cases usually involve larger businesses than this blog is targeting.)

In most cases, as counter-intuitive as it might seem, your best bet in working with a factor is to target your most dependable customers’ receivables for sale. Dependable means just that—it doesn’t mean quickest to pay!

The more dependable the customer’s payments, the less uncertainty in the relationship, the easier it is for the factor to get comfortable with the proposed transaction.

If you’ve got a customer who sometimes pays in 10 days and sometimes in 120 days, that’s tough for anyone to underwrite. But even if your terms are “net 30 days” and you have a customer who always pays between 50 and 60 days, the dependability of that experience will probably more than offset the lack of adherence to stated terms.

4. A factor is NOT A LENDER!

This really needs to be emphasized. When you deal with a factor you are not BORROWING. You are selling an asset, the account receivable, in exchange for another asset—cash.

The idea that money is being lent/borrowed and that the charge for that money is interest, is very deeply ingrained in many business owners’ psyches. But that is NOT the essence of the factoring transaction.

Both the nature of the relationship and its financial structure are quite different in factoring vs. lending, as we’ll discuss in later posts.

The Interface Financial Group has been helping businesses with their cash flow needs since 1971. Solving cash flow problems is what we do.

A Business Owner's Catch-22

The lead story in the NY Post’s business section this morning tells of a NJ business-owner who can’t get a loan from his bank.

“Where’s the news in that?”; you might ask.

Well, it’s not news, as we all know. The point of the Post’s article is the bank’s motivation for turning down the owner's loan request.

The article does bring up a very important point, though, because it specifically identifies the proposed USE of funds and the “Catch 22” nature of the owner’s situation.

The business featured in the article is 23 years old, profitable and grew by 16% last year!

The owner needs financing to hire additional salespeople. If he could add the staff he could increase his sales even faster but, and here’s the issue of course, he can’t hire the people without the cash to make the payroll.

This is a successful business that can become even more successful, but it can’t add sales staff because the new sales revenue will lag the payroll cost.

This is exactly the kind of situation that needs an asset-based solution! It’s not a problem business, it's a good business with a problem. It needs to accelerate cash receipts.

The owner could very likely establish a relationship with a factoring company allowing him to sell enough of his accounts receivable to generate the cash needed today to hire the new staff he wants.

This could be a temporary arrangement, funding the added payroll until the sales made by the new staff begin to generate the cash flow to support them. Or, it could become a longer-term part of his overall cash management and business growth strategies. Both options are available in the factoring market.

It’s just not necessary for an established, profitable and growing company to give up the opportunity for even faster growth because the banks are not willing to lend.

There are other solutions!

The Interface Financial Group has been helping businesses with their cash flow needs since 1971. Solving cash flow problems is what we do.

It Takes Money to Make Money

The old saying might be trite but it’s true. The fuel of business is money.

If you’re like many businesses these days the gas gauge looks broken: you’re running on empty.

It’s the perfect storm:

•Your bank line is either maxed out, reduced or maybe even cancelled.
•New bank financing is nearly impossible to obtain.
•Your home equity line might be in the same shape as your bank line.
•To add insult to injury, your customers are taking longer and longer to pay.
•The cash on your balance sheet is near zero but the payables balance keeps growing.

And if all that’s not bad enough, you’ve had to pull back on your marketing activities because if you DID get a new client or contract you wouldn’t have the cash to get the job done.

When there is no cash and no credit what’s the fuel source? How CAN you go after that new client or contract?

The answer might be staring you in the face!

On your balance sheet, usually right under the entry for cash, is the figure for your accounts receivable. In that big number that represents what your clients owe you; the number that’s become a real thorn in your side; might well be the solution to your problem.

How can that be possible?

It’s possible because the laws that govern commercial transactions usually allow those receivables to be SOLD. You can actually sell your right to receive the money owed to you and in doing so you can convert that receivable into the cash you need to pursue that client or contract.

And the transaction is NOT a loan. It’s simply the sale of one asset—the receivable—for another asset—cash. There is no new debt on your balance sheet.

The process is known as factoring. It can be used for one invoice; for the invoices of one or more specified customers or, in some cases, to an entire accounts receivable portfolio

How that’s done, why it’s been a well-known practice in many industries for decades, and how it can help businesses keep moving forward when other funding sources disappear,is the topic we’ll be writing about in this blog!

The Interface Financial Group has been helping businesses with their cash flow needs since 1971. Solving cash flow problems is what we do.