subject: Accounts Receivable Factoring Scenario [print this page] The business has loans from a bank or loan institution with liens filed against the business. The Internal Revenue Service has filed liens against the company. Suppliers also have liens filed against the business for invoices due or past due. The company has just barely been able to keep periodic payments up to date at the bank.
The business is growing and doing well but has cash flow problems due to a lengthy accounts receivable cycle and a short accounts payable cycle. Accounts Receivable are taking almost sixty days to collect whereas Accounts Payable are due in thirty days. What does a business due to correct the disparity between AP and the AR cycles in order to maintain a healthy cash flow.
You are picking up checks late on Thursday afternoon so you can meet payroll on Friday. Your suppliers have put you on a C.O.D. basis for new purchases or they have the company on a payment plan. It seems as though the forecast for the company is "gloom and doom" in spite of an increase of orders indicating a growth cycle. You should be excited about growth but depressed due to a lack of working capital.
Factoring is the conversion of accounts receivable into cash. Therefore, it does not adversely effect the balance sheet as a debt. It is the sale of an asset rather than a loan. It is an alternative way of generating cash immediately without creating debt.
Underwriters determine the discount rate in a proposal with no hidden fees. Once the agreement is made between a factor and a company, the factor advances about eighty-percent (seventy-percent for construction and up to ninety-percent for some industries). Once the client pays the invoice, the reserve minus the discount is paid to the company.
Once a company is set up for factoring, the amount of money available to the company grows automatically as the company grows, invoices and amounts increase.The company can use the funds as deemed necessary except when there are stipulations in such cases where a bank, supplier or Internal Revenue Services has agree to subordinate to the factor. In those cases, predetermined amounts would be paid first to satisfy those obligation. The rest of the funds can be used as the company deems necessary.
In order to solve the scenario created in the first three paragraphs, it is possible to get the bank, Internal Revenue Service and suppliers to subordinate to the factor or release liens due to subordination. The factor can pay directly to the bank, Internal Revenue Service and/or suppliers as invoices are submitted for payment. When those obligations have been met, the company can use the money as it deems necessary.
If a company is able to finance the first thirty days, it may chose to factor only the invoices past thirty days in order to save money. Outstanding accounts can be factored on the original funding. Thereafter, only new invoices are factored. The company receives funds within twenty-four to thirty-six hours from submission of the invoice.
It is important for a company to have a factoring broker who can match the company with a factor who knows about that particular industry. Most factors provide funding only for industries they understand. Most factors will not advance on construction but on the other hand, there are some who specialize in construction. Some specialize in third party medical. Others specialize in manufacturing.Factoring is possible only with business to business or business to government invoices.
Underwriters determine whether a company is viable as a prospect for factoring invoices. In some cases, companies can also qualify to factor purchase orders. Most factors who finance purchase orders finance products rather than services. When they factor invoices, the goods and/or services have to be delivered before the business can submit for and advance.
A business has to have people who know the time value of money. Mangement within the business also has to know the relationship of accounts receivable and accounts payable to determine their cash flow needs. A cash flow consultant can help determine needs in those aspects of the business.
If a business doesn't have adequate cash flow, it can not grow and flourish in spite of how many new orders. If there is not enough cash on hand to finance the next order, the company has great difficulty remaining viable.
When commercial loans are not an option, a company must look at alternative ways of financing. The application process for factoring is quite simple and quick. Most companies can start receiving immediate cash within about ten days from the date of the application. Thereafter, invoices are paid almost immediately.
