Tag Archives | factoring

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 the invoice is collected, the remaining 20% (less a fee) will be paid 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. Information on the company’s customers will also be obtained.

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, a pre-funding audit of the prospective borrower will be required.

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 to be factored, with 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%.

The amount not advanced to the borrower is held in reserve. As invoices are paid by customers, the amount held in reserve is released to the borrower, less a discount fee.

The discount fee is a percentage determined by a fee schedule which is laid out in the factoring proposal. The fee is a function of the time it takes for the invoice to be paid plus a variable component which is based upon the prime lending rate. The less time it takes to collect, the smaller the fee. The discount fee is applied to the amount of funds advanced to the borrower.

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

Factoring Lender Reports…..What they give you

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.

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, by invoice number, the invoice amount, the date payment was received and the 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.

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, 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.

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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, 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, you should examine it from several perspectives, knowing what, when and where to Factor 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, and 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 Should You 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. 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 such as the exit fee and the delinquency fee, but you must ask. Also, you may want your legal council 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.

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.

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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

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 use the lender’s reports as the source document for these journal entries. 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. These are:

Factored Invoices Sold (FIS): a contra asset account.
Factored Invoice Reserve (FIR): an asset account.
Factored Fees Expense (FFE): an expense account.

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

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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 each invoice is identified 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. The other $ 1,000 will show up as a fee expense on the P&L statement. Upon full payment, the A/R (asset account) and the FIS (contra asset account) will both “zero out”

Step 3- Partial Payment of Invoice(s) by Customer If a customer short pays, 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

Tracking your cash flow is 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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Journal entries for factoring receivables

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Accounting For Factored Receivables

See Also:
Factoring
Another Way To Look At Factoring
Journal Entries For Factoring 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
The What, When, and Where about Factoring

Accounting for Factored Receivables

Accounting for factored receivables is one of the more troublesome issues for controllers of entrepreneurial and middle-market companies. This is often due to unfamiliarity with the factoring process and the reports provided by lenders. The accounting treatment of factored receivables by first-timers while technically correct may ultimately be self-defeating. By being “correct”, the controller will have actually increased the vulnerability to their accounting process and system. This is mainly due to a series of possible mistakes their direct reports may make. Here are some common mistakes that occur when first-timers account for factored receivables.

Common Mistakes When Accounting for Factored Receivables

Most accountants attempt to record the 80% of Sold Transactions in the accounts receivable sub ledger. In other words, they will account for the 80% sold of each invoice for each customer. So what? Technically, this is correct. However, in the real world this could lead to a series of errors when entering in each transaction. Why? First, this strategy effectively doubles the workload FOR THE SAME TRANSACTION for the person responsible for keying in the information. Second, this means that the system is now open to twice as many data entry errors. Third, and most importantly, you are now unable to obtain an accurate A/R Aging Report and Customer Statement. The reason for this is because you have effectively netted out the factoring advances against the total invoice amount. In other words, your customer reports will now only show what your factoring partner “hasn’t paid for” (i.e. the net amount).

How to Account for Factored Receivables

Okay, fine. So how does one treat factored receivables? The answer is to set up a contra asset account as a control account in the current asset section of your chart of accounts. Gross advances by the factoring lender should be recorded as a single line item once a day as opposed to the sum total of individual invoices (i.e. Total Daily Gross Advance(s) = Sum of 80% of All Daily Invoices). When your reserve receivables come in (net of fees), record them as you would a daily deposit. Afterwards, make sure you follow-up and review the factoring lender’s reports to double-check for mistakes. In this manner you can tie their reports to the journal entries booked into your accounting system.

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