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Financing Solutions

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Factoring has origins that tie to the international trade industry back 400+ years. By the twentieth century factoring became the predominant form of financing for the textile industry. Today factoring is used across all industries but is still most prevalent in the garment industry. There are two methods of factoring: recourse and non-recourse. Under recourse factoring, the client is not protected against the risk of bad debts. On the other hand, the factor assumes the entire credit risk under non-recourse factoring and the full amount of invoice is paid to the client if the invoice becomes a bad debt.

Perception of Factoring
Despite the fact that most large corporations have in place processes to deal with suppliers who use third party financing arrangements. Many entrepreneurs remain very concerned about notification of their clients by a factor. Even so, some industries have a perception that a business that factors its debts is in financial distress. Factoring can provide a source of financing during the process of restructuring a firm even in bankruptcy so that it can survive and grow. With today’s tight credit markets it is common that a company is seeking capital to support or help fuel growth because of success and opportunities.

Why use factoring?
Factoring is a way for a company to obtain cash to meet current obligations, increase inventory, finance growing sales, meet payroll and operating expenses, and take advantage of trade discounts. Factoring allows a company to grow at rates that are off the charts.

Who uses factoring?
Today factoring is used by companies in most industries where there has been a product or service provided and the company is waiting for payment. While factoring is an attractive alternative to raising equity for small fast-growing firms, the same financing instrument can be used to turn around a fundamentally sound business whose management has encountered a perfect storm or made significant business mistakes which have made it impossible for the firm to work within the constraints of their bank covenants. The value of using factoring for this purpose is that it provides management time to implement the changes required to turn the business around.

The association of factoring with troubled situations accounts for the half truth of it being labeled “last resort” financing. However, use of the technique when there is only a modest spread or profit margin is not advisable for long drawn out turnarounds.

Common Characteristics of Companies
  • Start-up entity or one in business for a short period of time
  • Business experiencing rapid growth
  • Seasonal Business
  • Business with large contract or Purchase Order
  • Leveraged Balance Sheet
  • Unable to meet current loan net worth or ratio covenants
  • Inadequate Cash Flow (DSC)
  • VC Backed or IPO Bound
  • Loan Workout Situation
  • Transition/Turnaround Situation
  • Debtor-in-Possession Situations

Industries of Companies:
  • Gas & Oil Service Industry
  • Commercial Light Manufacture
  • Temporary Staffing & Staffing Agencies
  • Freight Industry Company
  • Food Snack Manufacture
  • Industrial Services
  • Distributors
  • Importers
  • Janitorial Services
  • Machine Shops
  • Security Guards
  • Wholesalers
  • Government Contracts
  • Construction Supply
  • Contractors

How Factoring Works
Factoring involves 3 parties. The first entity is company A, the seller. The second entity is the factor, the purchaser. The third entity is company A’s customer, the debtor. Company A sells its asset the accounts receivable from their client, the debtor, to the Factoring firm. The factoring firm verifies the invoice and notifies the debtor before releasing the funds to company A. The factoring firm purchases the receivable for typically 80% of the face value. The debtor then sends their payment to the factoring firm according to their terms with Company A. The factoring firm receives the payment and takes their fee out of the 20% reserve and the remainder is given back to Company A.

 Accounts Receivable Financing
Accounts receivable financing is the next step toward traditional financing or bank financing. Typically a company’s financials will reflect positive trends and be closer to qualifying for traditional financing. Typically a company will be profitable but may lack in leverage or secondary support for a traditional line of credit. Accounts receivable financing is similar to factoring by using the accounts receivable as collateral but has many differences in the structure and controls on the credit facility. Accounts receivable lines have similar advance rates as factoring but the pricing is usually less expensive. The one control that accounts receivable financing normally does not require is the notification to the debtor. Factoring requires that each customer, debtor, of the borrower be notified that the invoice has been assigned to the finance company. Accounts receivable financing will typically require a lock box for the remittance of payments but will allow the customer to collect the receivables. Another difference is that accounts receivable financing will have periodic audits on the collateral as compared to verification of the invoices before each funding. These are just some of the key differences between factoring and accounts receivable financing. Like factoring accounts receivable financing can enable a company to increase inventory, finance growing sales, meet payroll and operating expenses, and take advantage of trade discounts.

 Inventory Financing
Inventory financing is provided in conjunction with accounts receivable financing, with the accounts receivable portion as the primary component of the facility. Inventory financing is provided to assist you through the process of purchasing, processing, and converting your inventory into salable goods. Advance rates on raw materials and finished goods vary between 20-50% of cost, depending on the type of inventory.

 Purchase Order Financing
Purchase order financing is a funding option for businesses that need cash to fill single or multiple customer orders. In many businesses cash flow problems exist. There will be times where there is simply not enough money available to cover the costs of doing business. As a result, there may be an order from a client that isn’t able to be fulfilled due to a lack of cash. A company may not be able to afford the supplies necessary to meet the client’s particular needs. Having to turn the order down would obviously mean loss of revenue and perhaps even a tarnished reputation.

If word gets around that a company is turning away business because they can’t afford to complete jobs, customer trust is diminished. Businesses that considered giving that company their business will likely think twice. Therefore, to avoid such scenarios, it is imperative that businesses find the money that they need. For some companies, purchase order financing is a way to go.

Purchase order financing involves one company paying the supplier of another company, for goods that have been ordered to fulfill a job for a customer. This is an advance and may not be for the entire amount of the supplies, but it will cover a large portion of it. The purchase order finance company will then collect the invoice from the end customer. These fees are taken out of the collected invoice. The remaining amount is returned to the company.

Unlike bank financing, purchase order financing hinges mostly on the financial strength and creditworthiness of the company who has placed the order with a particular business, and not on the business itself. This makes it a viable option for new businesses and those with significant growth.