WHERE DID FACTOR FINANCE COME FROM?
The reality in Canada is that as a country we came late to the factoring party for cash flow needs. Factoring started in the U.S. and Europe and has been established for hundreds of years. As a result, the factoring that tends to dominate Canadian business financing, both in business model and pricing is heavily influenced by a small number of foreign firms in the asset based lending area of Canadian business.
The history of factoring in fact reaches back to ancient Rome, where producers and merchants employed a mercantile agent or “factor” who would manage their sales. Records show that these factors continued in use throughout the Middle Ages with increasing frequency.
SOME BASICS ON THE FACTORING FINANCING RECEIVABLES FINANCING SOLUTION
We should probably do a very short ‘primer’ on factoring to ensure we’ve got the basics in place. Factoring or receivable financing is the sale of your invoices or accounts receivable to a third party. It is very dominant in certain industries, i.e. trucking and transportation, staffing, etc., but quite frankly is now prevalent throughout Canada in many industries. What differentiates factoring is really the three points we’ll discuss
Who is offering it to you
What it costs
How does it work?
We recommend to clients that they deal with Canadian firms when considering a factoring option. Because this business financing is somewhat unique and misunderstood we strongly recommend you work with a trusted, credible, and experienced advisor in this area who can guide you through what many consider the factoring maze.
So let’s get back to our three key areas: First factoring firms vary in Canada by size, geography, and financial capability. You need to align yourself with a party that is most suited to your type of business, the size of your receivables portfolio, and the ability to deal on a one-on-one basis on any issues that come up. As we stated, it seems common sense that your best partner will be a Canadian firm that has direct representation in your geographical area.
WHAT IS THE COST OF FACTORING
Let's move on to point # 2 - Is factoring outstanding invoices expensive? We always hate saying this, but the answer is that it depends. Receivable financing certainly has the aura of being expensive, and unfortunately, most clients we meet are always focused on the rate. A few key points need to be made, so let’s be clear on this issue.
First of all factoring in Canada has a discount rate of between .75 -1.5% per month. We use the term discount rate because the industry itself doesn’t view the rate as an interest rate; it views it as essentially a reduction in your overall gross margin. Let’s use a quick, clear example. Let’s say you have an invoice value on an invoice of $100,000.00.
Factoring allows you to get approximately 90% of the funds ( the ' advance rate ) on that invoice the day you generate the invoice. (The balance, 10%, is paid to you when your customer pays) and out of that holdback comes, say a 1% discount fee to the factor firm) the factor industry view that 1% as a commission for financing your invoice.
THE COST OF CARRYING YOUR ACCOUNTS RECEIVABLE
If your customer pays in 30 days Canadian business can be forgiven by saying – I paid 1-1.5% per month, that’s 12-18%% per annum which is expensive. That's one reason invoice factoring /invoice financing can be your competitive edge in funding your business.
SOME KEY BENEFITS OF A/R FINANCING
One of the main points we can make when advising clients on a proper factor financing facility is that the funds you get on immediate cash conversion can be used to purchase inventory at a better price for cash, or alternatively, you can take the many 2% net ten day discounts many suppliers offer. If that was the case on all your business we can make the statement that you are recovering 100% of your financing costs via this strategy, plus you have unlimited working capital. That’s financial power and a great way to benefit from the factoring fee in your factoring facility.
SUMMARY OF KEY BENEFITS OF FACTORING
- Increase in cash flow / fast funding approval process
- Competitive fees due to industry competition from various financial institutions and commercial finance companies
- Provides a better way to address a cash flow forecast
- Provides credit insights into your customer base
- Offers the key benefit of the ability to pay key vendors and suppliers promptly while offering extended credit terms to key customers
- Businesses choose non recourse factoring can eliminate bad debt risk
HERE'S THE BEST FACTORING FINANCE SOLUTION - AND IT'S ' CONFIDENTIAL'
For our third and final point we address the issue of customer intrusiveness. We alluded to the U.S. and U.K. firms who follow a very clear process on the receivable financing for your firm – they send your invoice to your customer on your behalf, they corresponded with the customer, and they call your customer for money.
But, and this is a large ‘but’ did you know that with proper negotiations and the use of a proper advisor you can negotiate and implement a CONFIDENTIAL RECEIVABLE FINANCING facility that allows you to bill and collect your own receivables without long term contracts, while at the same time getting all the benefits of factoring – i.e. immediate working capital and cash flow?
CONCLUSION - ACCOUNTS RECEIVABLE FINANCING
In summary, for some growing businesses and small businesses factoring can be easily misunderstood as well as understanding the benefits of factoring. Assess what you think is wrong or might not work with this method of financing, and develop a receivables financing strategy with the knowledge that you will not be making the mistakes of others who are less ill-informed.
Talk to 7 Park Avenue Financial, a trusted, credible and experienced Canadian business financing advisor who can assist you with your business finance needs.
FAQ: FREQUENTLY ASKED QUESTIONS/ PEOPLE ALSO ASK / MORE INFORMATION
WHAT IS FACTORING
Factoring, also known as invoice factoring/invoice discounting is a financing transaction for small and medium-sized businesses to meet short-term cash flow needs. Factoring services, via Factored invoices, can be financed by a business as soon they're invoiced, which means that companies don't have to wait until later when money might already be due by the invoice date within the process of factoring.
The factor or factoring company pays what's owed on the invoice - Invoice factoring companies take a ' factoring fee ' . Many factoring companies offer recourse or non recourse factoring - the latter eliminating bad debt risk. An example of factoring in finance is a distributor who offers extended payment terms to clients but wishes to receive cash upon invoicing and delivery. Factoring is a short-term financing solution for businesses.
WHO ARE THE 3 PARTIES IN A RECEIVABLE FACTORING FINANCE TRANSACTION
The 3 parties involved in a factoring transaction are the company that wishes to finance their receivables under a factoring contract, the debt factoring company that purchases and financed the accounts receivables, and the end user customer who is obligated to pay the invoice. Companies using confidential a/r financing solutions, aka ' non notification' can choose to bill and collect their receivables.
WHAT IS SPOT FACTORING?
Some businesses may choose to sell or assign only some of their unpaid invoices / accounts receivable at any given time, ie a specific invoice / specific invoices to a factoring company- This is known as ' spot factoring' and allows a business borrower to receive payment immediately on certain invoices without waiting for clients to pay the invoice/invoices. A financial institution such as a commercial finance firm can accommodate this type of financing.
ARE THERE DISADVANTAGES IN FACTORING?
Financing of accounts receivables is successful when invoices reflect products and services delivered without disputes from clients.
Other potential issues to consider are :
Financing costs will lower profit margins so a/r finance solutions work well for firms with good gross margins - customers should be aware of any hidden fees
Commercial finance firms/factoring companies take security over the receivables they finance, as would a bank
Companies who sell to clients with marginal credit or who present collection risk will find it difficult to finance a/r
Termination of a factor facility requires a firm to retire all debt owing to the factoring company that has financed the receivables
Some clients of firms who factor a/r may not wish to participate in this type of financing, although this is rare
Businesses should only consider a/r finance when working with reputable firms and experienced business financing advisors
What is an example of debt factoring?
