What, When, and Where about Factoring
In order to make a well informed decision on using factoring services, a CFO must understand the factoring product, truly if you do not; your company should not be using it. But to understand the factoring product, examine it from several perspectives. When you know the what, where, and when to factor, you can answer some of those basic questions.
What is Factoring
Factoring is the purchase of qualified Accounts Receivable or invoices by a factoring company from an operating business in order to provide immediate Cash Flow to that business. Most factoring Purchase Lines allow for you to sell your invoices at 80 to 85% of face value up to a 45 day period from the invoice date. Typically, you can age the invoices up to 90 days from the purchase date before you must buy them back from the factoring company.
Some factoring companies collect your invoices for you and some do not. Some banks allow for you, the client, to collect your own invoices, and use their treasury management services as a mail box for the collection of the invoices. Pricing is typically based on the risk of the deal, size of the deal, and the volume of invoices sold each month. Finding the proper factoring company with the best pricing and the ability to create a strong banking relationship is as important as the characteristics of the deal. That is why the banks have been so successful with their product. They offer the best of both worlds: very competitive pricing and the ability to develop a long term banking relationship.
When To Factor
Deciding when to factor may be the easiest decision to make in the factoring equation. Any transitional need in a company can create a factoring situation. High growth is usually the most common in the Texas market, however, lack of capital, high debt leverage, payroll tax problems, or just not being able to meet your payables within their terms are all reasons for using the factoring product. Always, the primary goal is to increase your cash flow and allow you to smooth out the up and down swings which are created by clients that do not care to pay their bills in a timely manner.
The time value of money becomes critical in these situations, and it seems to be the norm that the larger the client, the slower they pay. This is especially true in the staffing industry where payrolls must be met on a weekly or bi-weekly basis. But clients pay in a 45 to 60 day period subsequent to receiving their bill. Whatever the reason, cash flow is the key element in building and growing a strong business, and if this is your hope for the company you represent as a CFO, then factoring your receivables could be the answer.
Where Should You Factor?
Deciding where to factor is probably the hardest decision to make once you have concluded that factoring may be the answer for your company’s needs. There is a variety of independent and bank owned factoring companies to choose from, and they all have their own cash flow programs. Coined phrases for cash flow solutions are the norm, but keep in mind that there are many differences to their services. Commitment fees, exit fees, delinquency fees, and then standard “factoring fees” all contribute to your cost for the service. Many companies prefer bank owned and operated factoring programs because of the banking relationship it creates and generally lower rates due to the bank’s low cost of money. However, some prefer the service you get from the smaller, independent factoring companies. But keep in mind that you generally pay for that service.
Review Legal Document
Regardless of what type of factoring company you pick to purchase your invoices, always review with a keen eye the legal documents, they will tell the story on the cost of the service. Make sure you have a thorough understanding of the rights of the factoring company and the control they have over the cash flow of your company. Many times you can negotiate away the extra fees, but you must ask. These fees can include the exit fee and the delinquency fee.
Involve Legal Counsel
Also, you may want your legal counsel or your CPA to take a look at the agreement to better define the ramifications for issues that naturally occur in your business, but may not be in accordance with how the program works, like having 60 day payment terms to some of your customers. This small, insignificant issue could put you in default of the Purchase and Sale Agreement and result in higher factoring charges to your company. Clearly, having your council review these documents prior to their execution could save you thousands down the road.
Ask for References
Lastly, a real acid test for a factoring company is to ask for references, and find some clients that are no longer with the factoring company, as this could tell you volumes on how they treat their clients, and how well their services work on a day to day basis. Good factoring companies should have no problem allowing you to check them out. Since factoring is largely unregulated, you owe it to your company to do at least this much due diligence. Good luck and may your cash flow freely.
For more tips on how to improve cash flow, click here to access our 25 Ways to Improve Cash Flow whitepaper.
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