Peter MacDonald
"Taming your cash flow: Factoring receivables can help you ride out the rough spots"
Profitguide.com

Making the sale does little for you until the cash comes in. Sometimes, it doesn't come in soon enough. It's an age-old problem: uneven cash flow, whether caused by growth spurts, seasonal sales or unco-operative customers, makes it difficult to fill orders or expand operations. And banks don't finance a healthy order book.

More Canadian companies are turning to factoring to level out the ups and downs. Though little-known in Canada outside of a few industries, factoring is a well-established financing tool around the world. Here's how it works. Factoring firms advance you up to 95% of the value of an invoice, for a fee. You can factor some or all of your invoices. No more discounts to encourage fast payment. No need to sell equity to keep the coffers full.

However, factoring isn't for every company; it costs more than a bank line of credit and can even lead customers to question your firm's financial health.

Rob Bennett's experience shows the benefits and dangers of factoring. In 1998, his Victoria-based Municipal Software Inc. was expanding rapidly as local governments in the U.S. gobbled up his product. But his receivables were running at $500,000 and many customers took longer than 60 days to pay. Although Bennett had never suffered a bad debt, his bank feared he'd have trouble collecting from his U.S. accounts and refused to extend his line of credit past $50,000, no matter how hard Bennett pleaded: "There was a gap there that banks just wouldn't fill for us."

Bennett signed up with Dynam Capital Corp., a Vancouver-based merchant banker and factor. Bennett invoiced his clients and got an immediate cash advance from Dynam; when customers paid Bennett, he paid the factoring firm. "It was just perfect," he says. "It provided cash, it didn't involve our clients at all and it was very easy to administer." As for cost, says Bennett, "The annualized interest costs were 10%, but we were dealing with very short periods."

Then the rules changed: for reasons unrelated to Municipal, Dynam insisted that Bennett tell his clients to pay Dynam directly, a common stipulation. Bennett balked. "This sounded like a trustee in bankruptcy," he says. "We didn't want our clients to think we were in financial trouble." So Bennett terminated the arrangement, tightening up his collections process to the point that he now collects most receivables within 30 days. But factoring had done its job, allowing Municipal to get past its cash-flow crunch.

Spooking clients is still a concern for companies that factor their receivables. The problem is ignorance: factoring has been around as long as banking itself, but it's relatively unknown in Canada outside of a few industries such as clothing and telecommunications. Fewer than 1% of Canadian small and medium-sized firms used factoring in 2000. As a result, some customers assume that suppliers who use factoring must be in financial trouble and can't be relied upon. Firms with strong balance sheets can avoid the problem by negotiating deals that don't involve notifying their clients, says Roy Murad, a partner with Toronto-based corporate-finance consultants Link Resource Partners.

Some of the stigma will disappear as more companies learn about factoring out of necessity. As banks move lending decisions away from the branch level and adopt generalized rules that can't customize loans to match the risks of each particular receivable, they're decreasing the amounts they're willing to lend. (In the garment industry, says Murad, banks will now advance only 55% of an invoice, down from 90% a few years ago.) Factoring can fill the void.

For some companies, the cost of factoring might be prohibitive. At 10% a year, Bennett paid substantially more than the going rate for a bank line of credit. Companies with already thin margins may find this unsustainable. Murad advises finding a factor that has worked in your industry; factors that are comfortable with your sector and know your clients will see lower risk and offer better terms. Ask your banker or accountant for a referral. (Chances are other companies in your industry won't tell you if they're factoring since, says Bennett, "There might almost be a feeling of shame associated with it.") And you need solid customers, says Toronto financing consultant Brian Moskowitz; factoring firms won't advance on dubious accounts.

For companies that are basically healthy and only need to smooth out troublesome cash-flow bumps caused by fast growth or seasonality, factoring is a time-tested source of quick financial help. It certainly worked for Bennett. Today, Municipal Software is one of Canada's fastest-growing companies - a profitable, publicly-traded business with annual revenue exceeding $3 million. "We're ahead of the curve enough that monthly cash-flow variations don't affect us," says Bennett. "But I don't know how we would have done it without factoring."

December 2002 / January 2003

Obtained from profitguide.com

William Elliot
"DNA Capital"
Peer-to-Peer, profitguide.com

The word 'factor' comes from the Latin factare meaning 'to make or to do'. This financing mechanism dates back to the time of Hammurabi and has been part of the basic fabric of all trade.

The concept of 'making it happen now' continues. Essentially it is the sale or assignment of a sale, trade, or accounts receivable account for immediate cash. By definition, it provides any business from start-up to mature companies (at any size), access to immediate cash and improved cash flow for expansion or growth but without diluting equity or incurring debt.

Advantages of factoring:

• Fast and easy to set-up
• Improves cash flow
• Leverages off your customers credit
• No consideration of your business's credit rating
• Continuous source of operating cash
• No long term contracts
• No personal guarantees
• Faster payment
• No debt creation - no monthly or balloon payments
• No geographical limitations
• Can be used to replace foreign receivable insurance
• Comprehensive credit service support
• Credit screening & monitoring
• Early detection of customer service problems
• Detailed management reports
• Professional collections
• Reduces overhead - can replace in-house credit management
• Greater operating efficiency
• Off balance sheet financing
• Provides "time value" of money
• Retain control of your business - do not give up equity
• Reduces bad debt
• Offer credit terms to customers
• Meet increasing sales demands
• Stop offering early pay discounts
• Flexibility - factor one or as many receivables as you wish
• Take advantage of trade discounts from suppliers

The essence of the transaction is the credit worthiness of the particular receivable account. Regardless of stage of development (even in bankruptcy), immediate cash may be available.

Factoring is not a collection system for bad debts or even slow pay accounts. Use of factoring may, however tend to speed the payment from an otherwise slow-pay client once the disciplined payment techniques of a qualified factor are introduced. As with any 'financial tool', there may be wide variations in applicable terms, conditions, and cost rates for its utilization.

For example, advance rates (percentage of invoice paid in advance of collection) may vary due to account risk, industry, and factoring firm. The discount rate (fee charged by the factor for the financing) may also vary by actual risk in the account, industry, and / or factor firm. Transactions may either be 'recourse or non-recourse' (return liability or guarantee of collection from the firm) which may take the form of merely replacing a receivable if it reaches a previously agreed upon age.

All of these variables then come together in a 'risk evaluation' cost rate or fee for the factoring service. As with any type of financing, the greater the perceived risk, the greater the cost for the service. The range for the first 30 days might be expected to be 2% - 7% of the gross value of the account financed, with 5% being typical.

There may also be a wide variety of other terms and conditions in the transaction such as:

• Minimum invoice amounts (i.e., $200 - $500), minimum monthly volumes (i.e., $10,000 - $500,000), and / or time period commitments (i.e., 6 - 12 months)
• Notification and non-notification to the receivable account that a factoring transaction has occurred

Just like all financing options, the business firm must evaluate its own individual needs and requirements including a focused evaluation of all actual or potential advantages versus the costs in the transaction. In most circumstances and at every stage of development, factoring, if properly utilized, can be a very valuable financial tool to achieve expanded sales and company growth.

Not all factoring companies are alike, often with wide variations in terms, conditions, and rates depending on your firm's needs and accounts receivable (as well as size and geographic coverage - local, regional, and national, international).

The use of a Business Finance Consultant will allow you the expertise of choosing from number of financing options and financial companies to suit your company's needs. There is usually a 'no charge' consultation for new companies to allow the consultant the opportunity to assess your needs and the effect your borrowing requirements may have on existing financing already in place. The consultant has a funding relationship with several lenders and will know which lender best suits your requirements as well as the type of financing which is most appropriate for the transactions required. The Business Finance Consultant will not usually charge you a fee as they are paid a referral fee from the Lender.

From: Profitguide.com