Saturday, August 29, 2009

Choosing the Right Financial Partner

One of the most difficult questions to answer is: Which company should I work with?

If you are at the point where factoring and/or PO funding is being considered, I highly recommend that you arm yourself with a basic understanding of the process and a series of questions for any funding company representative you talk with.

Below is a list of basic questions you should get answers to prior to making a decision to enter into a relationship with a financing institution. If the representative is unwilling to talk with you about any of the items below, or makes you uncomfortable when asking questions you have to think about what that says regarding his or her company.

The decision to work with a factoring / PO funding company should be made with care since they will be in communication with your customers. Make sure you are comfortable with whomever you choose to do business and that they have your company's interests in mind.
  1. Is your company financial stable and how long have you been in business? This should be the first question you ask. If they are not willing to talk about their finances and history, why should you talk to them about yours? Ask for their most recently available financial statements (they will probably ask you the same), and if they are unwilling to provide them, walk away.
  2. How does your funding process work and do you offer both AR and PO funding? If so, do you do both in-house, or do you partner with another company? Generally, this is pretty standard in the industry, but some companies charge their fees out of the advance they give you and others take the fees out of the reserve portion once your customer makes payment. Have them explain to you in detail how the actual operation of the relationship will develop. What documentation do I need to provide for funding, when will I receive the advance, do you make calls to my customers, when do you release the reserves? All good questions to ask. Most factoring companies only offer receivables financing and use a third party company for PO funding even though they may market that they offer both. There are a couple of companies that offer both in-house and are usually more cost effective.
  3. Can I factor if I have a loan, line of credit, or back taxes outstanding? Some financing companies will consider funding even with your business assets secured by another institution. Most commonly, factoring companies will require a 1st position security interest (lien) against, at minimum, your accounts receivable. If you have an existing lender (or government lien) in place it doesn't mean that you cannot factor, just that you will need to work with your existing lender and the factor to either takeout/payoff the existing lender or get a subordination from them. In some instances, you can work out a paydown schedule or installment plan that will allow you to move forward with the factoring company.
  4. How does your application process work, how long will it take, and are there any application fees? Your time is valuable and you don't want to waste it on companies that charge application fees. If the company you are talking with charges an application fee and/or files a UCC-1 financing statement on your company (a blanket lien against your company's assets) at the time of application, walk away. Find out what kind of documentation you need to provide to get a decision from them. Usually, all that is required to get a proposal is: signed application, accounts receivable aging detail, your customer list, and an invoice trail showing all paperwork from a recent transaction (i.e., PO from customer, invoice to customer, and proof of delivery; PO funding requires some additional paperwork related to the front-end/supplier side of the transaction). Depending on how much financing you need, you may also have to provide recent financial statements, accounts payable, and additional transaction histories. You should expect to pay a due diligence fee to any company you want to consider working with, but you should not pay it until you have a proposal in hand. Most companies should be able to give you a proposal within 48 hours of you giving them all the documentation they need to make an informed decision.
  5. Do you require monthly minimum invoicing or a minimum contract term? Most factoring companies do require a 12 month committment with minimum invoicing expectations and charge penalties for not meeting them. Find out ahead of time what programs are available to you from any financing company you talk with since many have different product offerings. Do not be afraid of making a committment to a company so long as you are comfortable with the expectations. Find out what happens if you want to exit the contract prior to the end of the term. Most companies will penalize you for early termination. This is not a bad thing, just make sure you are committing to what you are comfortable. If you are a startup company this can be worrisome and potentially dangerous. Find out if they have any products the will allow you to waive minimums for a period of time, or if they have any products designed specifically for startup companies. The good ones do.
  6. How is your pricing determined and what should I expect regarding fees? There are a number of different ways to set price in a factoring relationship. You can have a flat fee, a percentage fee on the gross receivable for different periods of time, administration charges, fees on the actual funds advanced, facility fees, lockbox fees, wire fees, credit check fees, lien/UCC search fees...the list can go on and on. There are two main ways funding companies price their services: discount and availability pricing. Discount pricing is where you get charged a percentage of the gross invoice. Typical discount pricing is structured so that you get assessed one discount rate for the first 30 or 45 days, then a smaller rate for each additional 15 days thereafter. This can be sliced and diced any number of ways: one discount rate each 10 days, or one discount rate to cover that administration and a much smaller one on a daily basis. Typical availability pricing is structured so that you get assessed a small discount rate on the gross invoice and an indexed rate plus (i.e. Prime or LIBOR + 3.5%) on the net funds employed (actual funds advanced). Make sure you help the representative understand what terms you offer your customers and what their payment trends look like so the both of you can come up with the best pricing model for your business.
  7. Have you worked with businesses in my industry before and are we the right size for you? This can be critical. Some factoring companies specialize in specific industries such as apparel, staffing, or trucking. If you are a manufacturer of technical electronic equipment and are talking to a factoring company that specializes in trucking, this may be a disaster waiting to happen. Find out if they understand your industry. This can be done most easily by paying attention to what kind of questions the representative is asking you. If they are really trying to understand how you do business and how your invoicing process works, then you probably have a company that should be considered. But, if they don't seem to get it, it might be time to look elsewhere. Also, some factoring companies only work with small to medium sized businesses, others just the really big ones. Find out if there is a fit here before going through the application process so you know they either have enough funds to work with you or too much so you would be lost in the shuffle.
  8. How will I know what's going on with my customers and their payments? Major question. If payments are now being made to the factoring company or a lockbox, how will you know when those payments are received? If the company does not have available to you internet account access you may be left in the dark about what is happening with your customers. Find out if they have the technology in place for you to be able to log into an online account to see payment history, account aging, and copies of cleared checks. It is in your best interest to have direct access to this information. If they don't, consider talking to other companies.
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Purchase Order Finance

The days of easy credit are gone and we probably won't see them again for a number of years. Markets have tightened across the board, banks are hoarding cash, and you are unable to finance orders you have on hand (or could have on hand). If you could only find a way to get your suppliers to release goods, you would be able to pay them because you know your customers are good for the money.

Sound like something you've experienced?

Well, my friend, you are not alone. Many business owners find themselves in similar situations: They have the opportunity to take on a potentially valuable order, but do not have the means to pay their suppliers due to cash flow issues, maxed out credit lines, or a lack of terms with their supplier.

There are usually a couple of reasons a business needs this kind of financing. Large orders, seasonal sales and business expansion are most common. Sometimes a company may have funds available to finance an order, but has opportunity elsewhere and just needs to find additional sources of funding.

Fortunately, there is a way to make this work without having to fork over 100% of the cost of goods to your supplier. It's called purchase order (PO) finance, and there are a couple of ways it can be done.

  • Making Direct Payments to your Supplier

A PO funding company can advance up to 100% of the confirmed purchase cost to your supplier by paying them directly and taking ownership of the goods. The funding company then collects the invoice payment from your customer and pays you the balance between the order value and the amount paid to your supplier, minus fees, once payment has been received.

  • Issuing a Letter of Credit

This is a commitment to pay the supplier on their fulfillment of certain conditions backed by either a Bank or the PO funding company. The conditions are normally related to the provision of correct documentation. These Letters of Credit are governed by the regulations of the International Chamber of Commerce. Terms are negotiated directly between your supplier and the funding company, and the Letter may be opened prior to production or just prior to shipping, whichever works better for the transaction. Funds are typically released once the goods are delivered to the buyer, but may be released "against docs" while in transit.

  • Supplier Guarantee

This is a commitment to pay the supplier by the funding company from the availability (funds) generated on the funding of the receivable created once you invoice on delivery of the goods related to the purchase transaction.

As you can see, there are a couple of ways to keep your business moving even if you don't have the ability to fund these opportunities yourself.

Friday, August 7, 2009

The Basics of Factoring

What is receivables funding?

Factoring is where an advance of cash is made to a Client against the purchase of an accounts receivable by a financing company (aka Factor). The Factor then proceeds to collect the receivable. The balance of the receivable less any fees due to the Factor is then payable to the Client on collection of the receivable by the Factor. Factoring is an effective way for a business to finance growth or to assist in the restructuring of a business. It also does not lead to any loss in equity of your business nor does it involve taking specific security over personal assets.

For instance, you sell your good or service to your customer in the normal course of business. Once your side of the transaction is complete and your service has been provided or your product delivered you generate an invoice for your customer that states they owe you X dollars within 30 days for what you have given them.

At this point you would normally have to wait those 30 days (payment is always right at that 30 day mark, isn't it?...) prior to receiving the cash you are owed. Factoring changes that.

When you factor your invoices the factoring company will advance you a percentage of the invoiced amount shortly after the invoice is created. This percentage is usually between 80 - 90% of the gross invoice amount. So instead of having to wait those 30 days for your cash, you are able to receive the majority of it almost immediately after you deliver your good or service.

The difference (that 10 - 20%) is held by the factoring company until your customer makes their payment through a lockbox. Once the payment is made, you get all of that back minus the fees for the service.

Fees range quite a bit between different companies and are structured based upon your customers' credit and the amount of invoicing you do and the factoring company's cost of funds (what their money costs them), but are generally small compared to what can be done with the available cash. There are some instances I have seen where companies actually come out ahead of the game and are effectively PAID to factor their invoices. This can happen when a company is able to take advantage of early pay or bulk discounts from their suppliers (sometimes enough by itself to cover the cost of factoring) and is able to put the free cash to use. It is truly an amazing concept! I believe Warren Buffett calls it negative float for his insurance businesses.

Thursday, August 6, 2009


What I have found in the world of receivables finance is that most small to medium size business owners (outside of trucking and apparel businesses) are mostly unfamiliar with the mechanics of how this type of financing works.

Statistics have been presented that show over 70% of small business owners in the United States do not even know that there is a way to accelerate the conversion of your accounts receivables to cash.

I know in these challenging economic times that a majority of those people could benefit from learning about the concepts behind factoring their invoices and, in some instances, using their purchase orders as a means to obtain the support of a funding company.

The most frequently asked question I get is: How does this work?

It is really pretty simple. If you sell to creditworthy business customers on terms of say, Net 30 days, there are companies that will provide cash against that invoice.

How many situations have you experienced where your customers are taking longer and longer to pay and if they would just pay you a bit faster you would have been able to take on more business.

What about being able to meet payroll, taxes, and other operating costs?

I know plenty of people who just don't want to wait 30, 45, even 60 or 70 days to get paid: Are you one of them?

This blog will attempt to explain different aspects of how this kind of financing works, provide examples of how it has helped other business owners, and the various specialized products available.

If you have any suggestions for topics, or just have questions, please do not hesitate to contact me and share your thoughts.
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