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What is Factoring Receivables

See Also:
Another Way To Look At Factoring
Accounting for Factored Receivables
Journal Entries for Factored Receivables
Can Factoring Be Better Than a Bank Loan?
History of Factoring
How Factoring Can Make or Save Money
Factoring is Not for My Company
The What, When, and Where About Factoring

What Is Factoring Receivables?

Factoring receivables is the sale of accounts receivable for working capital purposes. A company will receive an initial advance, usually around 80% of the amount of an invoice when the invoice is purchased by the lender. When they collect the invoice, the lender pays the remaining 20% (less a fee) to the borrower.

There are two types of factoring conditions: 1) Factoring With Recourse and 2) Factoring Without Recourse. The term recourse refers to whether or not the shareholder(s) of the company are personally liable for the factored receivables in case the company’s client(s) don’t payback the invoiced amount. By far most factoring relationships are conditioned upon With Recourse terms. By shifting more of the risk onto the shareholder(s) of the company, the factoring lender is able to then charge lower fees.

Qualifying for Factoring

The first step in receiving factoring financing is to be pre-qualified by a factoring company or a bank’s factoring department. Typically, this will entail an in-person meeting to review why the company is in need of factoring, as well as the provision of a company’s financial statements and supporting schedules (such as receivables and payables aging schedules) to document its operating history. They will also obtain information on the company’s customers.

A proposal for a factoring relationship will be created. This document will outline the proposed terms of the financing, including a facility limit, advance rate, discount fee schedule, repurchase provision, other fees, liens, process for notification of assignment, confirmation of receivables, and reporting requirements.

The proposal will be negotiated between the company and the representative(s) of the lender before being submitted to the loan committee of the lender for approval. Typically for proposed credit facilities of $1 million or more, lenders require a pre-funding audit of the prospective borrower.


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Factoring Operations

In a factoring relationship, all payments collected for accounts receivable are to be sent to the lender, typically to a “lock-box” under their control. Customers are to be notified of this by a Notification of Assignment letter which will also contain the new payment instructions. Invoices sent by the borrower to their customers will be required to contain the new payment instructions as well.

The borrower decides what invoices to factor (“sell”) by notifying the lender, through the use of a document typically known as a “Schedule A” form. This document will list each individual invoice that needs to be factored. It will have details such as the customer name, invoice number, date, amount, and corresponding purchase order or reference number of the customer. The Schedule A is to be accompanied by documentation which substantiates that the goods or services have been provided to the customers. The lender will decide which invoices it will purchase and then will advance funds to the borrower. This advance is based upon an agreed upon advance rate. The rate is typically around 80%.

Discount Fee

Hold the amount not advanced to the borrower in reserve. Then as customers pay the invoices, release the amount held in reserve to the borrower, less a discount fee.

The discount fee is a percentage that a fee schedule determines. The factoring proposal lays out the fee schedule. The fee is a function of the time it takes for the customer to pay the invoice plus a variable component. The variable component is based upon the prime lending rate. The less time it takes to collect, the smaller the fee. Apply the discount fee to the amount of funds advanced to the borrower.

For those invoices not collected within 90 days of the invoice date, a repurchase provision will apply. This requires the borrower to buy back the invoice, along with a late payment fee (around 5%).

Factoring Lender Reports…..What They Give You

Purchases & Advances Report

The lender will provide a Purchases & Advances Report, which identifies the invoices purchased by the lender, along with the advance rate and amount of each invoice advanced to the borrower. This is typically available daily online.

Collections Report

Lenders also provide a Collections Report, which lists all payments received from a borrower’s customers. Remember that the lender will receive and process all payments for a borrower’s receivables. There are two formats for a Collections Report. Format A lists all payments received for a borrower’s receivables and identifies those which apply to non-factored invoices as well as factored invoices. The detail on a Format A report will include the following:

  • Invoice number
  • Invoice amount
  • Date payment received
  • Amount of the payment collected for each invoice

The second format of a Collections Report is Format D. On a Format D report, information about the reserve refund and discount fee paid out of the reserve for a given invoice is also provided.

Reserve Report

The Reserve Report provided by a lender details changes in the borrower’s reserve account. As invoices are paid and processed, the factoring lender will remit the remaining portion of the reserve. This is usually 20% of the leftover invoice, net of fees. Should there be any outstanding invoices that a customer has not paid back within the agreed upon time period, the factoring lender may require the company to buyback that invoice AND still charge a fee. This type of situation is called “with recourse” because the lender can force the company to “buy back” delinquent invoices.

The borrower is usually required to provide monthly financial statements, including A/R and A/P aging schedules, within 30 days of a month’s end.

If you want more ways to add value to your company, then download your free A/R Checklist to see how simple changes in your A/R process can free up a significant amount of cash.

factoring receivables

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Factoring: What, When, and Where

See Also:
Another Way To Look At Factoring
Accounting for Factored Receivables
Journal Entries for Factored Receivables
Can Factoring Be Better Than a Bank Loan?
Factoring is Not for My Company
History of Factoring
How Factoring Can Make or Save Money
What is Factoring Receivables

What, Where, and When To Use 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 use factoring, 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 Use Factoring

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 You Should Factor

Deciding where to factor is probably the hardest decision to make once you conclude that factoring is what 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.

when to use factoring

when to use factoring

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Journal Entries For Factoring Receivables

See Also:
Factoring
Another Way To Look At Factoring
Accounting for Factored Receivables
Can Factoring Be Better Than a Bank Loan?
Factoring is Not for My Company
History of Factoring
How Factoring Can Make or Save Money
The What, When, and Where about Factoring
Journal Entries (JEs)

Journal Entries for Factoring Receivables

The following scenario will provide a clear, simple and effective way to record journal entries for factored receivables. In the spirit of simplicity and efficiency, remember that your journal entries ought to be booked only once per day on a daily summary basis (i.e. ‘ONE BIG JE ONCE PER DAY‘). You should then use the lender’s reports as the source document for these journal entries. But make sure you double-check your journal entries by auditing the report(s) sent by the factoring lender.

Case 1- Selling Receivables

Assumptions:

  1. Factored Receivable: $ 100,000
  2. Advance Rate: 80%
  3. Factored Fee Expense (FFE): $ 1,000

There are three accounts which need to be created to account for a factoring relationship based on With Recourse Conditions, including the following:

Step 1- Initial Funding by Lender

To account for the initial funding (when the lender selects the invoices from the Schedule A form to advance funds), make the following entry:

Assuming a $100,000 receivable with an 80% advance rate:

Dr. Cash 80,000
Cr. FIS 80,000

(If you want to manage and improve your company’s cash flow in 24 hours, download the 25 Ways to Improve Cash Flow whitepaper.)

Step 2- Receipt of Customer Payment

Accounting for customer payments will require the use of the Collections Report, which is produced daily by the lender. As you identify each invoice and the net reserve (i.e. the extra $ 20,000) is remitted by the lender, apply the payment to the invoice in the accounts receivable journal by debiting the FIS account.

Assuming a $100,000 payment in full by customer:

Dr. Cash 19,000
Dr. FFE 1,000
Dr. FIS 80,000
Cr. A/R 100,000

In booking the journal entries in this manner, your cash balance will increase by $99,000 at the end of the transaction cycle. And the other $ 1,000 will show up as a fee expense on the P&L statement. Upon full payment, “zero out” both the A/R (asset account) and the FIS (contra asset account).

Step 3- Partial Payment of Invoice(s) by Customer

If a customer short pays, then only apply the amount paid to the invoice in the journal in the manner above. For payments on non-factored invoices, apply against the FIR account.

Case 2- Handling Invoice Buybacks (When the Customer Doesn’t Pay You)

To handle the buyback of an invoice, make the following entry:

Dr. FIS 80,000
Dr. FFE 1,000
Cr. FIR 81,000

By tracking your cash flow, this just one of the many ways as a financial leader you can add value. For more ways to improve your cash flow, download the free 25 Ways to Improve Cash Flow whitepaper.

Journal entries for factoring receivables

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History of Factoring

History of Factoring

Factoring is a word often incorrectly used synonymously with accounts receivable financing. In Europe, the term “factoring” has become the term for accounts receivable financing in general; but in the U.S., this term refers to a specialized form of financing that involves the actual transfer of the ownership of the receivable to the lender, more accurately known as American Factoring. Factoring is a financial transaction whereby a business sells its accounts receivable (i.e., invoices) at a discount. Factoring differs from a bank loan in three main ways. First, the emphasis is on the value of the receivables, not the firm’s creditworthiness. Second, factoring is not a loan but the purchase of an asset (the receivable). Third, a bank loan involves two parties, while factoring involves three.

Parties Involved in Factoring

The three parties involved in a factoring arrangement are the seller, the debtor, and the factor.

The debtor owes the seller money, usually from the purchase of goods or services. It is common in business-to-business transactions for a seller to offer terms that allow payment for goods or services at some time after the actual delivery and acceptance of the goods or services.

Once the client (the debtor) has accepted the goods or services, the resulting obligation to pay the seller (usually represented as an invoice) becomes a negotiable instrument that can be sold.

In factoring, the third party in this transaction, the factor, buys the invoice(s) from the seller, usually at a discount to allow for the factor’s return and with a reserve, which is a margin the factor holds back until the receivable is retired by the debtor. Upon receiving payment on the invoice at its full face value, the factor remits the reserve to the seller.

Misconceptions of Factoring

There are many misconceptions about factoring, although it is an extremely old form of financing. It was first used in the U.S. in the textile industry, which was an industry of small, rapidly growing businesses selling to large retail chains and clothing manufacturers. It was also a common form of financing commerce in England, and some rules for factoring are even found in the Code of Hammurabi, the first set of laws governing commerce in ancient Babylonia.

For more tips on how to improve cash flow, click here to access our 25 Ways to Improve Cash Flow whitepaper.

history of factoring
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history of factoring

See Also:
Another Way To Look At Factoring
Accounting for Factored Receivables
Can Factoring Be Better Than a Bank Loan?
Factoring is Not for My Company
Journal Entries For Factoring Receivables
How Factoring Can Make or Save Money
What is Factoring Receivables
The What, When, and Where about Factoring
History of Accounting

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The Dreaded “F” Word

See Also:
What is Factoring Receivables
Accounting for Factored Receivables
Journal Entries for Factored Receivables
Can Factoring Be Better Than a Bank Loan?
History of Factoring
How Factoring Can Make or Save Money
Factoring is Not for My Company
The What, When, and Where About Factoring
Working Capital

Factoring: The Dreaded “F” Word

The dreaded “F” word, FACTORING. Now that factoring has been said, I am sure we all are feeling a little more at ease. I was in a meeting recently with a prospect, a Houston based oilfield servicing company, and their CPA whose name was John.

The company was experiencing cash flow problems because of growth. And they have more new business opportunities coming up in the near future. They were trying to determine how to capitalize on these opportunities in their situation of stressed cash flow. The topic of factoring their accounts receivable came up and John said “Only companies about to go broke factor their accounts receivable!” Knowing the CPA profession as I do since I was a CPA earlier in my career, I knew John’s concern was cost. So I had to ask him why he felt that way. He did not disappoint me when he said “factoring is too expensive.” I then told him that I would not normally recommend factoring to any client unless it will make or save them money.


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Situations Where Factoring Would Make or Save Money

John then asked me “Tell us some situations where factoring would make or save money.” Knowing that he thought he had me now, I gave him the following examples:

Conclusion

Taken back a bit John still held his ground by saying “It is still to expensive and it will break a company!” Being more perplexed than ever, I told John “Let me explain in terms I think you will understand.”

Let’s say the oilfield service company sells their service for $50 and has a resulting profit of $5. Now let’s say they have an opportunity for more business but do not have the capital (cash) to take on the jobs. So, would you agree they will not make any profits? John reluctantly responded with “Yes”. Let’s say the company has access to the capital (cash) presently locked up in their accounts receivable. Now, they can take advantage of their opportunity in the following manner. They still sell their services for $50 and now have a $3.50 profit instead of a $5 profit. In other words, your client will make $3.50 with me or $0 without me.

Before John had a chance to comment, the business owner said “I like your deal. Factoring can make me money.” Finally, John agreed, and the meeting moved forward.

For more tips on how to improve cash flow, click here to access our 25 Ways to Improve Cash Flow whitepaper.

factoring, Situations Where Factoring Would Make or Save Money
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factoring, Situations Where Factoring Would Make or Save Money

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How Factoring Can Make or Save Money

See Also:
What is Factoring Receivables
Accounting for Factored Receivables
Journal Entries for Factored Receivables
Can Factoring Be Better Than a Bank Loan?
History of Factoring
Factoring is Not for My Company
The What, When, and Where About Factoring
Nest Egg

How Factoring Can Make or Save Money

Opportunity for Discounts:

Lack of cash flow frequently causes a business to miss out on discounts offered by suppliers. Not taking advantage of these discount opportunities results in paying a higher cost of goods. Plus, many suppliers will negotiate even higher discounts for a customer who demonstrates the ability to consistently pay in cash within the discount period. Generally the best price is not the published price or terms. Rather, the best price is the negotiated price. This price is based on increased volume and negotiated terms backed by cash or quick pay. So, taking advantage of discounts gives a business the ability to add as much as 2 to 5 percent to its gross profit margin.

Administrative and Clerical Costs:

The clerical and data entry costs used in the physical processing of accounts are additional cost factors. Examples of physical processing include generating and stuffing statements. Depending on the size of the company and relative size of the accounts receivable, this may involve a full time employee, a larger accounting staff, or a current employee handling this responsibility as part of a diverse job description. The labor costs involved come into play on both ends. It includes:

  • The labor involved in generating and sending the statements
  • The administrative duties of receiving and posting account payments

Postage and printing costs add up when companies produce and mail large numbers of multi-colored statements on a regular basis. You must also consider these costs.

Management Resources:

Many overlook management’s time. In addition, many often overlook the missed opportunity of time spent doing something more productive. Reviewing accounts, placing calls to late-paying customers, and generating reports for analysis are all time consuming tasks involved in managing receivables and controlling cash flow.

Missed Opportunity:

Possible growth opportunities missed due to a lack of cash flow should also be taken into account when analyzing receivables management. Adequate cash flow is the single most important factor in achieving and sustaining business growth aside from market opportunity. Most businesses would have an extensive list of opportunities for growth and expansion to pursue if all receivables on the books were paid in cash today. Some examples of what could be accomplished if a company had access to cash instead of carrying customer debt include the following:

  • Bidding on new jobs
  • Investing in new equipment
  • Expanding the sales force

Furthermore, inadequate cash flow is like wearing handcuffs when it comes to growing a business. Improved receivables management, resulting in money in the bank and less or no debt, creates the environment and the attitude to set a goal and achieve the next level of growth and success.

Contributing Cost Factors

Once all contributing cost factors are estimated and totaled on an annualized basis, divide this number by total annual sales to determine a quantifiable cost for managing accounts receivable as a percentage of sales.

Payment Terms

Providing commercial customers with payment terms is a necessary part of doing business and an essential component of building good customer relationships. Performing this type of analysis on a regular basis highlights areas for additional savings and increases efficiency. In addition, knowing the actual cost of managing receivables and controlling cash flow allows for the implementation of more effective management strategies for the business as a whole. There are options available in the marketplace to help improve cash flow and receivables management, such as accounting consultant services, cash flow management systems, and factoring programs. Analyzing the true cost of receivables management is the first step in determining if these options make sense for a business by ultimately improving its bottom line.

If you want more tips on how to improve cash flow, then click here to access our 25 Ways to Improve Cash Flow whitepaper.

how factoring can make or save money
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Factoring is Not for my Company

See Also:
Another Way To Look At Factoring
Accounting for Factored Receivables
Journal Entries for Factored Receivables
Can Factoring Be Better Than a Bank Loan?
History of Factoring
How Factoring Can Make or Save Money
What is Factoring Receivables
The What, When, and Where About Factoring

Factoring is Not for my Company

I normally talk about real life situations when I talk about cash flow problems facing a company. This week, I am making an exception because factoring is the most misunderstood accounts receivable financing product offered to business owners.

Most business owners are led to believe factoring is only used by companies that are going broke. The truth of the matter is broke companies can not get any type of financing for the simple reason, they are broke. Factoring is mostly used by companies that do not have the invested capital from the owners to take advantage of business opportunities they have before them.

Following are questions I am frequently asked about the factoring process. What I have found is, once a business owner understands the factoring process they determine that factoring will solve their cash flow problems and needs.

1. What is factoring?

Factoring is a working capital funding product for a company’s accounts receivable. Furthermore, factoring will take the place of a traditional bank line of credit. Factoring must provide the company with a greater access to cash to fund growth. Factoring is a transaction whereby a financing company such as Summit Financial Resources purchases a business’s qualified accounts receivables.

2. How does factoring work?

Normally, within 24 hours of submitting a valid business’s receivables for financing, funds will be transferred to the company’s checking account. The amount of the initial funding is normally 80% to 90% of the face value of each invoice purchased. The balance of the factored invoice will be funded to the company’s checking account after full payment of the amount owed by the company’s customer, less the factoring fee.

3. Why do Business Owners factor?

Account Receivable financing allows a business greater access to cash flow which is capital. The reason the company has greater access to cash is the amount financed isn’t limited by the company’s financial condition but rather it is based on the financial strength of the company and of their customer base.

4. What are some benefits of factoring?

The following includes four important benefits from financing accounts receivable using factoring:

• Greater access to capital to fund growth compared to traditional sources.

• Reliability of the funding process, with straightforward guidelines for funding.

• Owners can expand their business without giving up ownership or control.

• Gain access to a professional credit management and collection process at no additional cost.

Having seen hundreds of companies utilizing factoring to grow their businesses, I know factoring is a great financing product. Remember, factoring must make or save you money to be the right funding solution.

For more tips on how to improve cash flow, click here to access our 25 Ways to Improve Cash Flow whitepaper.

factoring is not for my company

factoring is not for my company

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