Factoring Might Not
Be Right for You, But It Could Be Just What Your Customer
Needs to Pay You on Time (from the May 1999 edition of Credit
Although factoring transactions go back to the times of the
Pilgrims on this side of the Atlantic and even to ancient
Rome on the other, its major impact in the U.S. occurred in
the Garment District in New York City. Almost all business-to-business
transactions in the Garment District still involve factoring
in some fashion.
The typical factoring client often does one thing very well–provide
an excellent product or service. Sales are strong, growth
is rapid, and its customers are clamoring for help. The problem
is that growth that may be too rapid: inventories cannot meet
demand; service orders go unfilled; A/P is strung out because
cash flow is poor; and taxes get backed up. Too much time
is spent on crisis resolution and not enough on effectively
managing the growth.
The first step is often to turn to the bank. AAA Bricks
goes to Home Towne Bank to ask for a credit line. AAA has
had an operating account with Home Towne Bank for the whole
14 months of AAA’s existence. Since its business has
grown, AAA thinks that Home Towne will be able to give them
a line to meet expenses and help the company grow. Home Towne
Bank’s credit committee reviews the account, runs the
numbers through the bank’s credit scoring model, and
rejects the line. It determines that AAA has an insufficient
history, and it views the cash flow problems as a negative.
AAA then gets a tip from a colleague about Factor USA. Why
would a factor be willing to help when the bank just turned
down a loan? Because the bank and the factor are looking at
the same facts, but each from a different perspective. While
the bank looks at AAA’s financial strength, the factor
looks at the strength of AAA’s customers (known as debtors
in the factoring community). It sees AAA Bricks’ growth
as a positive and looks to partner with AAA to fund that growth.
Longevity, financials, and the principal’s history are
considered to be secondary to debtor strength and the ability
to get a security interest on the receivables.
Financing through a factor instantly speeds up cash flow.
Cash can be used to catch up with past due A/P, meet payroll,
buy equipment, increase inventory, meet vendors’ prompt-pay
discounts, fund new projects, and pay taxes.
Factor USA will review AAA Bricks’ debtors using traditional
credit management methods and do an overview audit of AAA’s
policies, procedures, financials, and principals. If approved,
AAA will send all invoices to Factor USA for factoring. Factor
USA will run the invoices through a verification process,
which generally involves contacting a random sampling of account
debtors to insure invoices are correct and proper for payment
(and have not previously been paid).
Once approved, Factors USA will wire AAA Bricks an advance
on these receivables, which can generally be 70 to 80 percent
of invoice face. Factors USA will take a security interest
in all A/R and any other assets as agreed. All debtors are
notified of this financing agreement and instructed to send
future payments to Factors USA. As invoices are paid, Factors
USA will deduct the advance amount and any fees accrued and
send the balance back to AAA Bricks.
Factoring & the Credit Manager
Credit managers often have clients that are strung out on
payments with no apparent hope of recovery. Prior to write
off or submission to a collection agency, the credit manager
might wish to consider referring the customer to a factor.
Many companies aren’t aware of the benefits of factoring,
and it just might be the best alternative for all involved.
In return for your help, the customer might be able to pay
off your invoices out of the first funding. Instead of no
or partial recovery, you get full recovery.
It’s Not For Everyone
Factoring isn’t for every company. Some are viable
enough for traditional bank financing. Some are in major financial
difficulty, and bankruptcy may be the only answer. Keep in
mind that factoring isn’t cheap; it often can be 1.5
to 2.5 percent of the amount of your receivables per month.
Margins must be sufficient to cover these rates, or a short-term
solution could turn into a long-term problem. But in the right
situation, factoring can provide enough working capital to
pay off the vendors and to grow the business.
Robert Holt is President, Baltimore
Credit & Collection Services, Inc.,