Factoring Accounts Receivable:

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IS A/R FINANCING THE SECRET TO GROWING YOUR BUSINESS?

When your payments from key customers are significantly slowing down, many firms in Canada turn to accounts receivable factoring/financing.

Otherwise known as 'factoring', it's a solution to working capital challenges. As unbelievable as it seems, in many cases it is not unusual to have clients tell us that receivables are getting paid in 90 days these days, sometimes longer in fact.

In receivable factoring, via a factoring agreement,a company sells unpaid invoices, or accounts receivable, to a third-party financial company known as the factor - Invoices are sold at a discount for immediate cash. For cash-strapped businesses with late-paying customers, accounts receivable factoring can help them get paid without having to wait and chase down customers.

Gone seem the days when the 30-day term on your invoice seems acknowledged and honoured!

Break Free from Cash Flow Constraints

Waiting months for customer payments while bills pile up creates dangerous cash flow gaps.

Let the 7 Park Avenue Financial team show you how factoring accounts receivable eliminates this waiting game by converting your invoices into immediate cash, ensuring your business maintains steady operations and growth momentum regardless of customer payment delays.

THE IMPORTANCE OF FINANCING YOUR WORKING CAPITAL

How effectively you operate your business will often be determined by how you use and finance your working capital -

It's a key issue that impacts growing your business, achieving the profits you want, and maintaining liquidity on a day-to-day basis to fund daily operations and meet your current obligations. Business lenders look to cash flow management as the measure of a company they will lend to.

THE WORKING CAPITAL DEFINITION

While the basic financial statement formula simply looks at your financial statements and sees the relationship between current assets and current liabilities (that's the working capital formula), the challenge is to generate cash flows around that working capital.

MAJOR REASONS TO CONSIDER FACTORING AND RECEIVABLES FINANCING

Business owners and entrepreneurs we meet here at 7 Park Avenue Financial will often question the need and reasons for ensuring you are funding sales through effective receivable finance and factoring receivables strategies.

In business, unexpected situations happen almost all the time, so the ability to fund emergencies and opportunities is a key benefit of good cash flow financing. Expenses of an emergency nature happen all the time!

Many businesses are seasonal or have a cyclical nature to them - knowing you have cash during peak or low periods is key to good business financing for reducing days payables outstanding.

Many firms are funded by short-term debt such as working capital loans, lease obligations, etc. Short-term liabilities are best managed through effective financing of your receivables generated by sales revenues. However, with working capital finance, you have the ability to manage day-to-day business needs.

For the majority of entrepreneurs we meet, it's all about growth, so working capital finance allows you to take immediate advantage of opportunities while avoiding negative cash flow -

Many owners and financial managers we meet are often consumed by the time they spend on cash flow concerns, so effective financing is a solid cure-all!

WHAT IS ACCOUNTS RECEIVABLE FUNDING/FACTORING: HOW ACCOUNTS RECEIVABLE FINANCING WORKS

Factoring finance allows a business to fund its sales through the sale of its receivables as the firm generates revenues.

The benefit of immediate cash brings liquidity and positive cash flow to the business. Businesses will typically receive 80-90% of their invoices as soon as a sale is made and products and/or services are delivered to clients.

The company receives the balance of the cash, less a finance fee, when the company's client pays the invoice.

The advantage of invoice discounting via this type of business finance is that long application times for more traditional financing from banks, for example, are eliminated, and positive cash flow allows a business to maintain positive cash reserves.

UNLOCKING CAPITAL AND ACCELERATING CASH FLOW

When those payments do slow down, that tends to cripple your cash flow. Naturally, the solution to the problem, or the obvious one to most business owners, is to make an all-out effort to improve collections but focus on increased accounts receivable turnover.

As an aside, we think it's very important that Canadian business owners and financial managers know their accounts receivable collection period – you don't have to be an analyst to do that. The simple DSO formula is as follows:

A/R times 365 divided by Sales for 365 days - That is the receivable turnover ratio for trade finance.

To illustrate, if your firm's year-end balance sheet has receivables of $400k and your annual sales are three million dollars, your collection period is 48 days. (We wish our collection period was 48 days, we can hear you saying!)

Naturally, you can alter the above formula on a quarterly or monthly basis by adjusting the A/R and sales level for your required period.

You can address the additional cost of carrying receivables by attempting to raise your prices with your customer to cover how to calculate accounts receivable factoring costs. However, that gets you profit and not liquidity. That is where factoring and receivable financing comes in.

HOW DOES ACCOUNTS RECEIVABLE FINANCING WORK

If your company needs A/R factoring finance, the ability to borrow on those receivables is easier than you think.

Any business selling to another business has the ability to finance their receivables - the overall general creditworthiness of your clients allows the finance company to determine the advances they will fund on your receivables on an ongoing basis.

A typical advance rate is in the 90% range - the 10% holdback is paid to your business when the client pays. This allows businesses to fund operating expenses and focus on sales growth and reduction of short-term or long-term debt.

Using a facility such as CONFIDENTIAL RECEIVABLE FINANCE, a business can collect its own receivables without any notification to the clients.

This solution is available through a pure factoring solution, or, if your firm is a bit larger ($250k+ in receivables), as part of a working capital facility or asset-based lending facility/revolving credit facility.

The challenge, we tell clients, is ensuring you have the type of facility and factoring partner that meets your overall goals in day-to-day business financing, and structure of your facility.

ACCOUNTS RECEIVABLE FINANCING VERSUS FACTORING

At 7 Park Avenue Financial, we often get asked to explain the difference between the bank or A/R financing/unsecured loans and the factoring process.

Both finance solutions provide funding based on invoice value - the key difference is simply the paperwork around bank financing, which advances funds based on an assignment of receivables, allowing the business to control day-to-day collections, etc. Typical bank advances are in the 70% range via the bank line of credit. Most factoring companies provide a cash advance of 80-90%.

Factoring finance, on the other hand, has paperwork that stipulates the sale of the receivables to the finance firm - in many cases, factoring companies also collect the receivables for which they have advanced funds. Factoring advances are significantly higher than bank advances.

So the key difference, depending on which form of A/R finance you are using, is basically a loan against invoices or a sale of invoices with appropriate paperwork by the bank or commercial finance lender. Costs in factoring are expressed as factoring fees, versus interest rates.

Is your firm a candidate for a factoring or accounts receivable financing facility? It probably is if your customer payments are slowing down, sales are growing, and you are unable to obtain traditional bank lines of credit from chartered banks.

Financing via receivable factoring companies is hugely popular in the U.S. - over $140 billion (yes, that's billion!) was done in 2009, for example, let alone current times. The Canadian landscape is much smaller and fragmented, but the bottom line is it's growing.

We can't over-emphasize to clients that your factoring facility grows with your business, and your factoring credit facility can be adjusted upward very easily in terms of your growth.

3 CRITICAL ASPECTS TO CONSIDER IN CHOOSING RECEIVABLE FINANCING SOLUTIONS

Is there any downside at all to a factoring and working capital facility? When we sit down with clients and work them through the process, we focus on 3 main areas:

Challenge: 60-day payment terms created cash flow gaps affecting payroll and inventory purchases

KEY TAKEAWAYS - WHY CASH FLOW AND WORKING CAPITAL ARE CRITICAL TO YOUR BUSINESS

Accounts receivable financing provides capital on your accounts receivable base to help avoid negative cash flow positions.

Financing of A/R can be done via a loan against receivables, or the sale of receivables - the only difference is the paperwork.

Technology has improved the processes around funding via receivable financing companies.

All businesses need to fund working capital needs for cash to meet obligations and run day-to-day operations.

Revenues and profits grow when good A/R financing, A/R management, and asset turnover are in place.

Businesses that have a longer operating cycle can benefit from orderly financing of receivables from sales revenues - return on assets is improved with good receivables management.

Banks and commercial business lenders measure a firm's success and liquidity around the firm's working capital finance success in debt management and collections.

CONCLUSION - GROWTH POTENTIAL AND ACCOUNTS RECEIVABLE FUNDING SOLUTIONS

Receivable factoring is important to businesses that need to fund operations on sales/unpaid invoices and who might not have access to traditional bank capital.

Speak to 7 Park Avenue Financial, a trusted, credible, and experienced advisor in this area of small business funding options, and we will ensure that you are comfortable that such business financing is the solution to your cash flow and working capital problems - i.e. the benefits of accounts receivable funding for immediate cash flow.

FAQ: FREQUENTLY ASKED QUESTIONS / PEOPLE ALSO ASK / MORE INFORMATION

What is accounts receivable financing? How does accounts receivable factoring work?

Financing receivables in a business is a short-term innovative finance solution that allows receivables from sales to be collateral for financing. There are different forms of receivable financing and various methods of A/R funding, including invoice discounting and receivables financing from traditional lenders. Businesses borrow against the value of the invoices. The types of receivable financing a firm is eligible for will depend on the criteria of traditional financial institutions such as banks or alternative financing providers such as accounts receivable financing companies.

The accounts receivable factoring company can offer non-recourse factoring on their invoice factoring services. The factoring fee will be higher as the lenders absorb bad debt risk when factoring receivables in this manner. Many factoring companies express factoring costs as a fee, versus an interest rate, when they quote invoice financing facility costs for a company accounts receivable balance facility.

What are 5 key differences in financing receivables versus factoring of receivables?

Key issues in comparing invoice financing versus factoring accounts receivables include:

WHAT ARE SHORT-TERM WORKING CAPITAL LOANS?

Many businesses choose to utilize short-term working capital loans (also known as an MCA/Merchant Cash Advance), which are structured as term loans as an alternative to funding receivables via debt factoring or unsecured bank loans and lines of credit. Rates are higher on these installment lump-sum type loans, but approval is very quick compared to applying to banks and other traditional lenders. Many providers provide online access to financing, and payments are flexible and structured to each firm's cash flow.

WHAT ARE FINANCING COSTS AND CREDIT APPROVAL RELATED TO FACTORING?

Accounts receivable factoring cost is based on a number of key factors and will depend on facility size and pricing. Companies selling to larger firms are viewed as having more valuable receivables based on general creditworthiness, etc. The age of an invoice will also factor into pricing, and generally receivables older than 90 days cannot be financed either through a bank or a commercial factoring company. Advance rates on the accounts receivables will also affect pricing, and companies with very poor credit may still have financing challenges. Many factoring companies advance approximately 90% of invoice face value in constructing their factoring costs.

Is accounts receivable financing a loan?

Accounts receivable financing, or AR finance via an invoice financing company, is not a loan per se - it is the monetization of a current asset that leverages the cash flow owing to the business. The invoices are the collateral for the receivable financing or receivable factoring facility.

Citations

' Canadian Business Financing With The Intelligent Use Of Experience '

ABOUT THE AUTHOR: Stan Prokop is the founder of 7 Park Avenue Financial and a recognized expert on Canadian Business Financing. Since 2004 Stan has helped hundreds of small, medium and large organizations achieve the financing they need to survive and grow. He has decades of credit and lending experience working for firms such as Hewlett Packard / Cable & Wireless / Ashland Oil

Factoring Accounts Receivable: Complete Guide for Canadian Businesses | 7 Park Avenue Financial