Learn to
Profit from
Factoring
The History of Factoring
Recorded history reveals that the concept of turning future payments into cash ( or cash equivalents) dates back thousands of years. Much like
today, the need for liquidity, or “cash” to pay everyday expenses, has always been a great need. Think of the days when merchants would travel the seas in search of various treasures. Ships would be filled with those in need of food and necessities to survive.
Financiers offered payments against future rewards as a means to earn a return on their investment. This financing was an integral part of the success in establishing world trade. Thus, the concept of factoring was born dating back some four thousand years.
Prior to the 1980’s, factoring was used primarily in the garment, textile, and furniture industries – typically only available to larger companies. Entrepreneurial funding companies, changed all this in the late 1990’s. Due to the recent credit crisis and bank meltdown (2008) more
companies than ever are turning to factoring to create immediate debt free working capital. And did you know Small to Midsize business bank loan application decline rates are continuing to reach epidemic
proportions.
Today factoring is becoming the alternative business finance tool of choice, in many cases the only choice. There are over 55 million Small to Midsize businesses across North America but, less than 10% of them
utilize factoring because most have never heard about the many benefits. SMBs assume factoring has overwhelming costs. However, the reality is factoring costs have been on a steady decline since 2008. Why?
Supply and Demand. Today, there are more factoring companies than ever, which results in lower costs as they compete for clients. The creation of The InvoiceXchange has a created a unique auction based more efficient marketplace providing the most liquidity for the least cost
with a simple process and flexible terms. This has created an
unprecedented income opportunity for working business professionals, corporate expatriates and business minded entrepreneurs.
Today big box retailers including Walmart have entire departments dedicated to working with their vendor’s factoring company. These big name brand retailers recognize that a factoring company has deemed their vendor as credit worthy and safe to business with - as more companies embrace the many benefits of factoring, the face of the factoring industry will continue to change forever.
The Facts
A recent study conducted by the Credit Research Foundation found nearly
80% of North American companies report that the economy has had a direct negative effect on their business with a majority citing:
1. Lack of Available Working Capital
2. Tightening of Cash Flow
3. Slow Down in Customer Payments
As the three major issues that are having disastrous affects on the viability of their businesses. Companies that were accustomed to
receiving payment on their invoices in 30 days are faced with the reality
that the payment cycle is now surpassing 60 days or longer. The national average for invoices to be paid across North America is a staggering 73 days!
The trickle down effect of this is tremendous. Without the needed cash flow, companies are forced to make tough decisions. Employees are being let go (no money for payroll), supplier payments are delayed
(resulting in delayed or cancelled shipments for future orders), delaying payment of operating expenses (negatively affecting the company’s credit history which will adversely affect their purchasing power), payment of taxes are delayed (resulting in judgments and tax liens) and the list goes on.
Banking versus Factoring
When cash flow is tight, where do companies turn? Traditionally, this answer has been to banks. Pick up today’s paper, listen to the news, research the internet and you will see that banks are NOT the solution. Due to the recent credit crisis, their directive had changed to protect their existing portfolios, while becoming extremely conservative in providing new loans (if any) due to loose credit policies of the past.
Today banks concentrate on generating revenue from deposits, bank fees and a whole host of ancillary services like insurance etc.
So, what is factoring?
The definition of Factoring is simple: The purchase of business to business (B2B) or business to government (B2G) accounts receivable (current or outstanding invoices) for products delivered or services that were rendered in the past, at a discount.
Factoring is NOT A LOAN and NO INTEREST is charged. It is simply the discounted purchase (sale) of a company’s non performing asset
(accounts receivable – an invoice that is paid over time)
Is factoring just for a few selected industries?
Factoring related transactions are somewhat vast. By definition, invoices must be from one business to another business or, from a business to the government. With this in mind, the number of potential prospects is HUGE! At the time of publishing this white paper, there were over 55
million SMB businesses scattered all across North America (United States and Canada). This number is sure to increase due to new start up
companies that have sprouted up recently, mainly as a result of those individuals that have been downsized and subsequently have started their own businesses. While many industries have been floundering over the past few years, the Factoring industry has been experiencing explosive growth.
Ask yourself this question: “How many businesses do you know of that provide a product or service to another business or the government”?
Now ask yourself: “How many of those businesses are getting paid in over 30 days? 45 days? 60 days? 90 days?”
Since just about everything in a factoring transaction is centered on an invoice, let’s see what a typical invoice may look like….
There are a number of sections that make up an invoice. Let’s quickly highlight and talk about an important section of an invoice. TERMS!
One of the most important sections of the invoice is the TERMS of payment. Typical terms in business are: 2% 10/net 30 days which means if the customer pays for the invoice within 10 days they will receive a 2%
discount off the face (total value) of the invoice. If the customer pays for their invoice after ten days, they are required to pay the total (face value) of the invoice. This is fundamental for the factoring industry. The longer the terms (time to receive payment), the larger the ultimate burden on the businesses cash flow.
How Factoring Works
First, let’s define the participants in any factoring transaction.
• Payee (Seller of invoices)
The Payee, also referred to as the “Seller”, is the company that has
manufactured a product and shipped that product or rendered a service to their customer. In the factoring process, we call the “seller” a
prospect/client. That company will now create an invoice for a sales transaction that has taken place and sends to their customer.
• Buyer (factor)
The buyer (factor) is the company that supplies the capital in a factoring transaction. The factor is commonly referred to as a funding source that buys invoices at a discount.
The payor is a company (customer) or government agency that makes payments against an invoice of the Payee, the “seller” (prospect/client). The factoring process begins when a Payee (client) is introduced to a Buyer (Factor/Funding Source). The Buyer then makes their funding decisions based on whether or not the Payor has the credit strength to pay for the invoices and how long they typically take to pay for their invoices.
The opportunity to make money in the factoring business is two fold. 1. As a Referral Source or Cash Flow Consultant (Broker) – Finding a
Payee (company) or referring a Payee that is in need of immediate cash flow the business needs to thrive on a daily basis.
2. As an Investor or Funding Source – Buying the payment or stream of payments (invoices) from a Payor (Customer) to a Payee (Company).
Yahoo Hotjobs Hot Professions
While this career may be foreign to you - it has quickly become a
hugebusiness in a massive multi billion dollar industry and just recently Yahoo Hot Jobs voted Factoring (broker) among top hottest professions. As reported by Joy Victory, Payscale.com. Here’s an excerpt...
Factor. A what? Didn't you study those in algebra? While this career is fairly foreign to most folks, now that bank loans are hard to come by, factoring allows small business to get funding based on their current accounts receivable -- the money they expect to have coming in. Factoring works well for retailers and other businesses that have receivables. Mitchell explains that factoring is a legitimate source of funds in hard times. He says, "Factoring is a huge business and, at a time when people can't get other types of lending, factors are skilled experts at lending against accounts receivables.”
There has never been a better time than right now to create another legitimate source of income by brokering factoring relationships.
The Factoring Industry is Recession Proof
Strong Economy - when the economy is strong companies will utilize factoring to accomodate the growth they are experiencing.
Weak Economy - when the economy is weak companies will utilize factoring to help them survive, stay current with fixed costs/taxes, meet payroll etc. With the banks not lending and customers on average paying their invoices in 73 days - the factoring industry is poised to experience another wave of tremendous growth.
How does Factoring work?
There are two key disbursements that are associated with a factoring facility. The first disbursement is called an “Advance” and the second disbursement is called the “Reserve”.
· Advance – the client receives up to 95% of the face value (total) of the invoice when the invoice has been purchased by the factor. The advance rate depends on the “risks” involved with the transaction – the greater the risk, the lower the advance.
· Reserve – the client receives the reserve balance (total invoice amount minus advance rate) once the customer has paid for the invoice – less the discount fee charged by the factor.
For example - if the invoice is $1,000.00 and the “Advance” has been set at 90% by the factor, then the “Reserve” would be 10% (100% of invoice - 90% = 10%). The reserve is released (paid back to the client) once the invoice has been paid by the customer (debtor).
To help you better understand the Factoring process lets define some of the most commonly used terms that are used in a Factoring transaction:
Factoring Terms
1. Invoice - a business document defining the amount owed for a service rendered or product sold and delivered. An invoice can also be referred to as a legal document, or a short term note to the customer, when terms are listed on the invoice.
2. Accounts Receivable - an invoice (or group of invoices) that remain unpaid and is due to be payable in the future.
3. Due Diligence - The process of evaluating the risks involved in funding a client. In factoring, this typically includes a number of actions including: review of financial statements, credit reviews on the clients customers, and payment history on past invoices.
4. Prospect – A company in need of improved cash flow that is seeking alternative financing options
5. Client – Once a prospect commits to a funding source (typically by signing a legal document called a “Factoring and Security” agreement), they become a client.
6. Customer/Debtor – the entity that has received a product or service and is now indebted to the client for payment. In most
alternative financing scenarios, this must be a credit approved business or some form of public entity (government)
7. Factor – a commercial entity that provides alternative financing options to various business. Factors specialize in purchasing business-to -usiness or business –to-government accounts receivables at a discount. 8. Discount Fee - the fee charged by the factor. The discount fee is
typically charged on the face value (total) of the invoices and increases as the invoice ages until paid by the customer/debtor.
9. Broker - the business or person responsible for the referral of a client to The InvoiceXchange.
10. Referral Fee - the residual commission of the Factor’s discount fee (up to 15%) that is paid to the broker (referrer) each time the Factor buys client’s invoices.
11. The InvoiceXchange - makes the daunting task of finding more cash flow easier for businesses. The InvoiceXchange is a no cost service to use that provides a unique auction based marketplace that connects business owners a group of North American wide factoring companies that each year fund billions of dollars of factoring transactions.
How do Factors make money?
When entering a discussion on how a factoring (funding Source) company makes money, you must first embrace the idea that a factor is not a
“lender.” This is a grave error perpetrated by many who not only enter the field, but also by those companies who are considering using
factoring as a tool to accelerate cash flow in their business.
Why is this important, you ask? It is important for a few reasons:
Annual Percentage Rate: We are all conditioned to believe the only way to get money is through a bank. After all, our first account was a passbook savings account at a bank. When we grew older and it was time to get a checking account, we secured this at a bank. To further the example, we ask: Where does the business owner turn to get a business checking account or a loan for his/her company? One thinks that the only place to get these things is… at a bank. Therefore, it is safe to assume that
whenever you are talking to a company about financing, they will equate factoring, to a bank.
We must emphasize again that banks charge interest on money they lend while Factors buy invoices at a “discount fee”. No Lending, Different
Regulations: Since factors are actually purchasing assets at a discount and not lending money, they are not regulated in the same way that banks are. This flexibility allows factors to pursue funding opportunities that are typically avoided by the banks (eg… Service companies, new start ups to < 3 years old, companies that are growing quickly, companies declined by bank, companies with historic losses or liens against them/ bankruptcy).
When banks says “No,” why will a Factor say “Yes”
Said another way, why would a factor fund a company that a bank won’t lend to? When a bank makes a loan to a company, they are relying on that company’s ability to pay back the loan. They look to hard assets likeproperty, equipment, inventory and cash as security in the event the company defaults on the repayment of the loan. When a factor purchases an invoice at a discount, they are simply relying on the client’s customer/ debtor to pay the outstanding invoices, in full. Ask yourself this question - how many companies do you know that are non-manufacturing
companies? Now ask yourself this question - how many of them do you think are getting paid in 30 days, 60 days, 90 days and longer?
To summarize, factors prosper by taking a different approach to
commercial financing. Banks are making their credit decisions based on the strength of the borrower’s assets. Factors make their credit decisions based on the credit strength of the Borrower’s customers.
How Does Factoring Work?
The following is an example to demonstrate how this works:
Invoice Amount: $100,000.00
--- Amount Advanced to Client = 90%: $ 90,000.00 Amount Held In Reserve = 10%: $ 10,000.00
30 Days Later:
Amount paid by client’s customer: $100,000.00 Advance amount back to factor: - $ 90,000.00
Discount Fee = 2.5% of invoice: - 2500.00
Amount Held In Reserve = 10%: $ 10,000.00 MINUSDiscount Fee 2500.00 _____________________________________________
Amount rebated to client: $ 8,000.00
During the transaction, the amount held back in Reserve serves to protect the factoring company against any potential credit offsets taken by the client’s customer (debtor). If there were a credit taken by the client’s customer, that amount would be subtracted from the “reserve” before rebating the remaining monies to the client.
As you can see, in total, the client received an advance of $90,000 and a reserve rebate of $10,000 for a total of $9,800. The factor received a discount fee of just $2500 for the service.
Now imagine a factor managing hundreds of thousands of invoices at any given time, all of which are being purchased at a discount. The yield can certainly add up for the factor and so can the residual referral fees
(commission) for the broker. Best of all, the client is getting the use of working capital which will make them stronger. A stronger client creates more invoices. In many cases that client will grow and factor all of their invoices.
Factoring Case Studies
Here are some real life case studies that will serve to better illustrate the benefits of factoring.
Health Care Staffing
First, we must define the players in the transaction.
· Payee – Health care staffing company providing nurses to hospitals on a temporary employment basis (client)
· Buyer – “”Funding Source” (factor) · Payor – Hospitals (customer) The Current situation:
Client was providing temporary nursing services to various hospitals. Client’s major operating expense was in meeting the payroll demands of its temporary workforce (nursing) on a weekly basis. Client was receiving payment on invoices to hospitals in 60 days. However, the client had the ability to “cash flow” these expenditures out of current working capital Client received a phone call from a very large hospital informing them they had been awarded a contract for 50 nurses to be employed 40 hours per week. The hospital was mandating 60 day payment terms on all
The Math:
Client (health care staffing company) pays its nurses (on average) $24.00 per hour.
Client charges it’s customers (on average) $36.00 per hour for hours worked.
Hospital pays its invoices for services provided by the client in eight weeks or every 60 days.
Client must pay nurses weekly for hours worked.
In order to fulfill this new contract, the client is faced with the reality of having to come up with $384,000 in cash to cover the payroll burden: 50 (nurses) X $24.00 (average hourly pay) x 40 (hours worked per week) x 8 (number of weeks for hospital to pay) = $384,000.
The Issue - The Bank:
Client approaches the bank to request a loan for $500,000.
Bank declines the loan due to “insufficient collateral” – only asset is accounts receivables. In addition, the health care staffing company had only been in business for 16 months and did not have enough financial history.
The Solution:
Client is introduced to the merits of factoring by an InvoiceXchange Factoring Consultant who gathers some simple information. The
information is forwarded onto the InvoiceXchange File Manager/Factor - a review of the credit history of the payor (hospital) determines it to be a solid credit risk. The Factor agrees to advance 90% against invoices purchased.
Keep in mind, the $24.00 per hour was not the amount that the client charged the hospital. If it were then the client would not earn a profit. In this transaction the client charged the hospital $36.00 per hour, so the
client earned $12.00 per hour (gross profit) for each hour the nurses worked ($36.00 amount charged to hospital - $24.00 amount paid to each nurse = $12.00)
50 (nurses) X $36.00 (average hourly pay) x 40 (hours worked per week) x 8 (number of weeks for hospital to pay) = $576,000
The Factor will “Advance” (first key disbursement) 90% against invoices created: $576,000 X 90% = $518,400
Note: Keep in mind that Factor will fund weekly based on verified hours worked per nurse. This figure provides an aggregate amount that is funded over the 8 week period.
Since the payroll burden is $384,000, The Factor’s advance of $518,400 is more than enough to cover the payroll and provide additional working capital over the eight week time period. The client now has additional working capital to source out new contracts, and to help meet fixed costs like rent, telephone, utility payments, etc.
The Factor in this case charged a discount fee of 5% or $512,000 x 5% = $25,600 Factor (discount) fee. If you were the broker that referred this deal you would earn $25,600 x $15% = $3,840 residual income each and every month that this sales transaction took place.
A win-win situation!
Delta Components
Delta Components, Inc. (“Delta”) is a relatively small distribution company located in Reston, VA. Delta currently has just over $500,000 in revenues and during the past year, Delta enjoyed significant sales growth. While most business owners would be thrilled to experience the growth that Delta has, Ron Cotton (Principal), was very concerned that his company’s cash flow status would be unable to keep pace with its sales growth. The majorities of Delta’s customers are strong financially and have a history of paying their invoices on time. However, “on time” these days
means 45 to 60 days. Delta pays their employees every week and they must pay their vendors in 30 days. The discrepancy between the time Delta needs to pay their employees and vendors has, and will continue to create a cash flow problem for Delta.
In an effort to meet his internal cash flow needs, Ron has delayed vendor payments resulting in placing his purchasing power at risk. This could result in his vendors implementing more restrictive payment policies (basically, Delta would need to pay faster, if not up front, in order to receive future shipments from the vendors).
This lack of cash flow has also caused Ron to take a pass on a number of significant business opportunities.
In Ron’s mind, it did not make sense to just take on new orders if it meant increasing his inability to pay his vendors on time, and most importantly, hindering his need to pay his employees on time. Let’s review the following table:
Delta Components, Inc. Current financial position (without factoring)
Yearly Sales $500,000
Variable costs (70% of sales) $350,000
Fixed Costs $50,000
Total Costs $400,000 Gross Profit/Loss (Sales - Costs) $100,000
Note: Ron has calculated that he has lost close to $200,000 in sales
opportunities due to the fact that he did not have the cash needed to pay his vendors on time, nor to pay his employees, which were both needed to fulfill on these commitments.
Ron was being forced to make a decision that would dictate the future success or failure of Delta. Find a way to increase the cash flow within the
company or continue to turn down future sales/growth opportunities. Ron reviewed his options for improving his cash flow.
First, Ron reviewed the options that were available to him without seeking financing:
1. Demand more strict payment terms from his customers 2. Increase the sale price of his products
3. Negotiate more conservative payment terms to his vendors 4. Reduce employee cash burdens (eg.... insurance, bonus, wage
increases or possible layoffs) 5. Delay his payment of payroll taxes
After much thought, Ron came to the following conclusions:
Options 1 and 2 were not possible. Demanding his customers to pay their invoices faster was a recipe for disaster as his competitors were offering more liberal payment terms now in an effort to induce his customers to conduct business with them. Raising his prices would position him as unattractive option to his customers. Ron was in a very competitive business, and his customers would simply choose to buy their products from another, less expensive resource.
Option 3 was not possible. His vendors had already placed him on credit hold. Asking them to now give him more liberal payment terms would be counter intuitive.
Option 4 was not possible: Simply put, if Ron were to increase his
business, he would need all his employees, if not more, to work for him. In order for him to either keep current or attract new employees, he would have to offer competitive wages and benefits to bring them to Delta.
Option 5 was an option, but, a potential “death blow” to Delta. Avoiding the payment of employee tax burdens to the government is never a good long term solutions. Although the impact of not paying the taxes will result in an immediate improvement in cash flow, the long term
If Ron was unable to “recover” cash by making internal changes to his business, he must now look to outside financing to help him.
Ron viewed his outside financing options as: 1. A line of credit with a bank
2. Offering ownership (equity) in his company, in exchange for working capital
3. Factoring Delta’s accounts receivables
It is necessary to keep in mind that while Ron was considering all options, he was losing orders (daily) with potential customers that may never
return.
Ron knew that a line of credit with a bank was not a valid option, as he attempted this in recent memory and knew that he did not have the collateral needed to secure a loan.
Ron had been approached in the past by a few potential “investors”, but this option came at a very high price, as he would have to give up
ownership and control of his company in exchange for cash.
Ron determined that an accounts receivable factoring line of working capital would be the best solution to help his company strengthen his company’s financial position. This would enable Delta to now accept new orders and to pay both vendors and employees on time. In fact, the
acceleration of cash into his business would put Ron into a position of strength with vendors in that he could now be in a position to negotiate early payment discounts.
Ron received a 90% advance from The Factor and a discount rate of 1.9% (per 30 days). Since Delta was now getting paid on average in 60 days, Ron budgeted a discount rate of 3.8%.
Ron then reconstructed his financial statements by adding the following: 1. The 3.8% factoring discount rate
2. The projected $200,000 increase in new business 3. Supplier discounts offered for quick pay.
Delta Components, Inc. projected financial position (with Factoring)
Yearly Sales $700,000
(Note: Increase of $200,000 from new orders)
Variable costs (65% of sales) $455,000 (Note: 5% supplier discounts)
Factoring discount fees
(Note: 3.8% of sales) $26,600
Fixed Costs $50,000
Total Costs $531,600
Gross Profit/Loss (Sales - Costs) $168,400 Additional Profit of $68,400, over 60%!
Therefore, by selling his invoices and ultimately giving a 3.8% discount to the factor, Delta gained over 60% ($68,400) in profits - truly, addition by subtraction!
The Factor in this case generated revenue (discount fee) totalling $26,600 If you were the broker that referred this deal you would earn $26,600 x $15% = $3,990 residual income each and every month that this sales transaction took place.
So In Conclusion - Why is the Factoring Industry important to You? Business Professionals, Corporate Expatriates, Business Minded
Entrepreneurs all across the country have learned to enhance their client/ customer satisfaction strategies by adding this invaluable service to what they are already currently doing. Small to midsize businesses across this country are desperately seeking what it is we have to offer and now you make a difference and help them Capitalize on their Potential.