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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.

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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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Financial Assets

See Also:
Accounting Asset Definition
Asset Market Value vs Asset Book Value
Long Term Debt to Total Asset Ratio Analysis
Return on Asset Analysis

Financial Assets Definition

Financial assets definition is a contractual security that possesses a claim upon a company or person’s real assets. In comparison, a company invest the cash received from issuing financial assets and invest in real assets.

Financial Assets Examples

Some examples include the following:

Stock – This is an investors claim upon the ownership of a company.

Bonds – This is a claim upon interest payments and a principal payment in the future from a company. It is a liability to the company.

Loans – Treat this financial asset the same way as the bond above.

Insurance – This financial asset pays out if the terms of the contract are met. In other words if a person has car insurance. The money paid monthly goes toward a financial asset that will pay off if that person has a wreck or if the car breaks down.

Note: These are only a few examples of financial assets, and does not incorporate all of them.

Financial Assets Meaning

A financial asset has a claim upon the real assets or tangible money generating assets owned normally by a company. They are often traded and offered in a financial asset market like the S&P 500 or the Dow Jones. As a result, this means that the value of a financial asset can often change. The main contribution of financial assets is to fund companies or money generating entities. They are offered in the market so investors can put their savings to work, and companies can invest in a real asset like a manufacturing plant to make money.

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External Sources of Cash

See Also:
Angel Investor
Categories of Banks
Commercial Paper
Common Stock
Convertible Debt Instrument
Venture Capital

External Sources of Cash

In another article, I told you about Sue and generating cash from sources within her business. I will not detail her entire story at this time, but will tell you that we were successful in obtaining external cash allowing her to grow the business with the piece of mind of a constant and predictable cash flow.

We need to make sure we are all talking about the same thing when we hear or see the phrase “external sources of cash”. So, today I am going to define external sources of cash, and in the future, I will share situations where the different types are best utilized.

There are two sources of external sources cash for businesses: lenders and equity investors. I will begin with the least costly.


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1st Source of External Cash: Lenders

Always remember that borrowing, no matter what the sources, will be less costly than equity. There are two classifications of lenders to discuss. However, within the classifications there are various sub categories. First and by far the least costly is traditional bank financing. What I am talking about here is when the bank takes all of the financial risk on your loan. Examples of these loans would be traditional lines of credit, loans for equipment, and building loans. Additionally, banks offer other products when they do not take all the risk and these products are more costly. Examples of these products are Small Business Administration (SBA) loans, equipment leasing, and factoring. Later in the series we will discuss the various differences in the lending philosophy of banks and different types of banks such as state vs. national, and community vs. multi state.

The second types of lenders are what I will call alternative lenders. Probably a term you may not be familiar with, but include such companies as asset based lenders, accounts receivable lenders, factoring companies and hard money lenders. These lenders take greater risk in their lending activities than banks. The reasons alternative lenders may be a better source than banks vary on a case by case basis. In future articles, each one of these will be discussed with examples and stories.

2nd Source of External Cash: Equity Investment

The second type of external cash for a business is equity investment. This by far is the most expensive cash or capital a business can acquire. You may be asking “why is this most expensive… I don’t have to pay it back”. Well, the answer is you are sharing part of your profits each year for the growth cash with your partner, and then upon the sale of the business, you share the return on equity with the partner.

Understanding the two different external sources of cash is critical because each or all may be needed in your business’s situation. For more tips on how to improve cash flow, click here to access our 25 Ways to Improve Cash Flow whitepaper.

External sources of cash

External sources of cash

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Due Diligence on Lenders

See Also:
Relationship with Your Lender
Finding the Right Lender
The Dilemma of Financing a Start-up Company
Every Business has a Funding Source, Few have a Lender
Angel Investor

Due Diligence on Lenders

I am sure all of you have applied for some type of a loan from some institution to be used for college, car, home or business. By the end of the process, you have given them applications and supporting documents that, in some cases, can weigh several pounds. When I am involved in a transaction with a client, I encourage them to do as much due diligence on my company, Summit Financial Resources, as we will do on them.

Example of Due Diligence on Lenders

For example, I was recently told by a business woman named Robin that all lenders are the same. A little concerned with her comment, I asked “Why do you feel that way?” She went on to tell me that banks are controlled by the government; therefore, all banks have the same rules, so all banks are the same. She continued by saying, “I just use the bank located nearest to my business.” I replied, “I agree that government does control banks. But, the government rules are guidelines, and the lenders create their lending policies and procedures from these rules. Therefore, each lenders’ policies and procedures are different, so you really should consider doing due diligence.”

The reason for the due diligence is to determine which lender understands your needs, and to make sure the lender’s policies and procedures will meet those needs. Also, I believe you should make certain the lender understands and values your business.

While looking at me as if she was not sure I was believable, she asked “What should I ask a lender? They have the money and I don’t want to make them mad by asking questions about them.” I replied by saying “Well, if that is the case, do you really want to get in a lending relationship with them?” Now appearing convinced, she wanted to know what she should be looking for in a lender and stated “All I know for sure is I need their money to have the cash to grow my business.”

Decide On The Lender

I told her, first of all, you need to decide what size of lender is appropriate and again, to make sure they meet your needs. In my opinion, location does not come into the mix. I categorize lenders into four groups, big market, middle market, small market and those in it for the money (I will share details of this conversation in next week).

Next, do you like the lender? Does he or she want to understand your needs and value your business? The lender is going to check out your credit and personal references, so ask the lender for some current or past customers. The lender’s customers can provide you with information on the lender’s strengths and weaknesses.

Another thing you want to talk about with the lender is their support staff. Make sure you are comfortable with the pre-funding and post funding support staff. By doing this you will know if the support will be via voice mail system, Internet, or a real person.

Robin did find the lender she liked with Summit. I visited with her later and she thanked me and shared the many successes her business has experienced. Then she told me she had shared her new found knowledge of due diligence with her business associates.

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Down Payment Definition

See Also:
Payment Terms
Notes Payable
Payroll Accounting
PEO Arrangement Compared to Outsourcing Payroll
Payback Period Method

Down Payment Definition

A down payment can be defined as an initial payment towards the financing of an expensive purchase. For individuals, this purchase is similar to a car or home. For businesses, however, this purchase could be a number of things: land, a warehouse, machinery, servers, or almost anything. Down payments are a deposit which assures to the financier that you will pay your debt. The down payment is usually larger than subsequent principal payments.

Down Payment Explanation

A down payment can be explained as a partial payment towards a purchase. They are made towards either trade credit or the financier of a purchase. It is decided on by the financier and accepted by the purchaser. A down payment is a percentage of the value of the loan.

Down payments are, in some senses, a goodwill measure. They ensure the financial stability and willingness to participate on the part of the purchaser. Though it may not seem like this, the down payment serves this purpose and is thus a staple concept when products are financed. The rationale is simple: if the purchaser is willing to pay the down payment the party is at least responsible enough to do so. The down payment mitigates some of the risk the financier takes when making an agreement with the customer.

Be weary of the no down payment business loans available on the internet. It is up to you to make sure you read all contracts fully. Financing a business is a difficult process, if someone is offering a deal that is too good to be true, chances are that it is not true at all.

Down Payment Example

Joey is going to purchase another 18 wheeler for his distribution business. He needs this tool to continue operations. Though Joey can not pay for the truck fully he can afford to finance it.

Joey has aligned a financier to help him cover the cost of the truck. The financier requires regular principal and interest payments to assure that the truck will be paid off. Additionally, the financier requires a down payment. The down payment, a somewhat substantial sum, establishes that Joey is willing to work with the party he is borrowing from.

Six months later, Joey completely pays off the truck. He does this simply and moves on to making more profits. By satisfying the needs of the lender Joey can move on to bigger and better things. Soon he will make a down payment on land in order to build a new distribution warehouse.

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Credit Life Insurance

See Also:
Employee Health Insurance Plan
Third Party Insurance
Personal Credit for Commercial Loan
How to avoid additional insurance premiums
Insulate Your Company from Rising Health Insurance Costs

Credit Life Insurance Definition

Individuals use credit life insurance policies to cover the outstanding debt on a loan. As the loan decreases, so does the plan until they both reach maturity, and the entire amount of the loan is due.

Credit Life Insurance Meaning

A credit life insurance policy is usually put on loans like a mortgage. Many adopt credit life insurance so their loved ones will not have to cover the cost of the mortgage or loan outstanding after their passing. The great thing for insurance companies is if the person lives to the maturity of the loan, then the amount gained through insurance payments is straight profit without having to account for any liabilities.

Credit Life Insurance Example

For example, George is 65 years of age. He just moved into a new house with a 15-year mortgage. But George has had health problems in the past. So he decides that he needs to invest in credit life insurance so that the mortgage burden will not be on his four kids. George ends up living throughout the entire loan; thus, the insurance plan has reached its maturity and won’t need to be exercised. It should be noted that if George had died during the time of the loan, then the insurance company would be required to pay out whatever amount that George owed on his mortgage. In this situation George’s debts would all be paid for without putting an unwanted burden on his kids.

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Financial Jargon

See Also:
Categories of Banks
Finding the Right Lender
Funding Source Versus Lender
How to Manage Your Banking Relationship
Interest Rate
Is it Time to Find a New Bank?

Financial Jargon

My client, Elliott, met a friendly banker at a networking function. The banker told him, “I like your business and would like to loan you and your company money”. Elliott spent time with him because he believed if he got to know him it would be easier to borrow money. But, when the time came for Elliott to borrow the money, the answer he got was no.

Elliott called to tell me he did not get the money and was upset because he thought the banker was his friend. My answer to Elliott was, “he probably is your friend. But, you are not getting what you want from the banker (money) because you are not communicating in his language.”

Elliott got mad during our conversation and said things like banks don’t loan you money unless you really don’t need the money. Then to make matters worse, I told him you, are probably right. He thought just because the banker was his friend and friends help friends in time of need, the money would be his for the having. After we talked a while and he settled down, I told him the problem. Bankers are the individuals who have invaded earth from another planet. They come from the planet known as Financial World. They look and act exactly like the rest of us that inhabit earth with one exception, their language. The language they speak is known as Financial Jargon.

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What is this Language of Financial Jargon?

Elliott asked, “What is this language of Financial Jargon?” I told him financial jargon is English or any other language spoken on planet earth but the majority of the human race does not understand the meaning of the words bankers speak. He asked, “Are you talking about financial ratios?” I told him yes, and gave him examples such as current ratioreceivables turnover, net working capital, gross margin, debt coverage, and debt to equity, which are just some of the terms in the language of Financial Jargon.

Sure, Elliott owns a business and survived college where he had taken a finance or accounting course. He even told me he had to memorize all the formulas to earn the grade he received. However, he went on to say, nobody told me I needed to understand the true meaning of these ratios to communicate with an alien known as a Bankers.

Ratios Hold Different Meanings for Bankers

Well, I told him these ratios do have different meanings to your banker than you were taught. Not enough time to teach him the entire language so I just explained one. I said debt to equity ratio could be defined as total debt to shareholders net worth. In college, you were taught this shows how leveraged a company is, in that the lower the ratio, the stronger the company.

To your banker, this ratio tells him who really owns your company; you or your creditors. Bottom line, if this ratio is high, your banker feels they are not talking to the owner of the company and will not loan you any money. So, Elliott, before you try to borrow money again, let’s make sure you are presenting your case in banker’s language.

Instead of using financial jargon around the executive team that doesn’t understand that language, break it down for them. Learn how you can be the best wingman with our free How to be a Wingman guide!

financial jargon

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