A popular alternative for companies who do not qualify for traditional financing is Accounts Receivable Factoring. Accounts Receivable Factoring is the sale of a company’s accounts receivable in exchange for immediate cash.
For many companies, accounts receivable represent one of the largest assets on the balance sheet. However, the asset lies dormant until the time of collection when it is converted into cash. Factoring allows a company to turn those dormant assets into cash.
Below are 10 facts about factor financing which companies should consider when exploring factor financing.
- It is not as expensive as you think
Over the last number of years, there have been many new alternative lenders entering the marketplace. With the increased competition, borrowing rates have seen an overall decline. Depending on the strength of the borrower, interest rates can range from 10% to 36% per annum.
- Companies who have hit a bump in the road can qualify for financing
For a traditional financing solution, credit departments make decisions based on the ability of the company to service the debt. With factor financing, there is a greater emphasis on the ability of the borrower’s end customer to repay debt. This allows for companies with poor credit history to potentially qualify for factor financing.
- A great option for a start up
The factor company’s credit adjudicators base most of their decision on the strength of the end customer, not the borrower. This will allow for a company with no credit history to potentially qualify for factor financing.
- Collect cash on the day of the sale
Some customers can take up to 90 days or longer to pay for products or services provided. This can make it difficult for companies to fill future orders from customers, as their cash flow is tied-up in the receivables. By factoring an invoice, the company can collect the majority of the funds from the sale on the day of the sale, which provides the company the necessary working capital to grow.
The majority of factor lenders now provide both notification and non-notification options. In a notification facility, the end customer is notified that their account (or invoice) has been purchased by the lender and all customer payments are remitted directly to the lender. In a non-notification facility, the customers will not know the company has factored its invoices and payments continue to be remitted to the company. Whether or not a company will qualify for a non-notification facility is based on the strength of the borrower as well as the end customer’s ability to pay the invoice.
- Insuring receivables can raise advance rates
Accounts receivable insurance is a great way for companies to reduce the risk of customers not paying for products or services provided. Lenders will typically advance funds at higher rates to companies who have insured their accounts receivable.
- Personal guarantees are typically required
Although not all lenders require personal guarantees from the principals or owners of the company, it is generally required when entering a factoring arrangement.
- It is possible to have additional assets financed by a factor company
Although the majority of funds made available to a borrower must be through factoring receivables, some lenders will also provide financing against other assets. Assets such as inventory, machinery, equipment, and real estate owned by the company may be added to the borrowing base to provide a higher financing availability to the borrower.
- Quick approvals
Unlike traditional banking solutions, factor lenders can provide approvals for financing rapidly. Lenders can quickly go through an accounts receivable listing, financial statements, and a business plan to make a decision on whether a company will qualify for financing.
Traditional lending setup costs could include legal fees, lender fees, and bank fees to setup a new bank account and wire fees for each advance. There could also be monthly monitoring fees and minimum revenue requirements.
Eric Friedberg is a Senior Consultant with the Business Financing group at Farber. He focuses on arranging innovative financing solutions for small and medium-sized enterprises(SMEs) and early stage companies. Eric can be reached at 416.496.3078 and firstname.lastname@example.org.