A familiar but difficult scenario unfolds. You are the owner of a growing jobbing company. Sales are up over last year, but success is causing stress.
You need a source of some quick capital to keep the company on-track.
A cheque expected from your largest customer has not arrived and your payroll is due tomorrow. The phone rings and your call display tells you that your key supplier is phoning you for the third time this week. You know what he wants, so you avoid speaking with him. Your banking facility and your charge cards are maxed out. What do you do?
When timing and access to working capital are critical, invoice discounting (also known as factoring) is a practical alternative to traditional methods of financing.
Factoring is a huge and widely accepted practice; however its benefits and concepts are often misunderstood or known only to professionals in the financial services industry.
Factored sales for 2004 were over $3.5 billion in Canada, $146 billion U.S. south of the border, and more than $700 billion U.S. worldwide. The rapid growth of invoice discounting/factoring in North America, and its extensive penetration into almost every industry, means that virtually all your major accounts will forward some or all of their cheques to factoring companies.
Why use invoice discounting?
We are living in volatile economic times, and traditional lenders are reducing their exposures.
A slow-motion credit crunch is underway. Banks are tightening their credit standards in the face of problem loans and declining credit quality. Small- to medium-size enterprises (SMEs) are most vulnerable to reductions or withdrawal of operating facilities for working capital under this scenario. This means that SMEs may need to find another bank to support their operations, or may need to work with an invoice discounter for a short period of time.
Invoice discounters provide more funds or availability than traditional lenders, and a regular and predictable cash flow, as and when required.
Factors often provide advances by working behind the bank as a source of secondary working capital. Factors can improve banking relationships, as clients can remain in covenant and in margin. In contrast to the banks, high growth, highly leveraged clients are attractive to invoice discounters who can supply some or all of their financing needs.
Decision-makers within factoring companies better understand your business and the variables affecting your normal course of business, including seasonality issues. Factors inherently offer a more favourable assessment of risk.
Quality of accounts receivable (A/R) is the common denominator, not equity base, liquidity, and cash flow. Customer credit limits are established on a pre-screened basis, allowing clients to stay away from potential problems.
Factors have a proven history of leveraging assets leading to accelerating sales growth and greater profits, which offset invoice discounting costs. This allows you to promote your business with confidence. Opportunities to do more business are not lost to competitors.
Invoice discounting terms and conditions vary, but generally speaking the following practices apply:
* Proposals/term sheets can be issued to potential clients in as little as two days upon receipt of the required information.
* Invoice discounting fees vary from 2% to 5% (or more) for each 30 days, calculated on the gross sale value.
* No minimum term (length of time) contract is required; this means that a client can work on a “spot” or “as needed” basis.
* Notification – Customers are aware of the invoice discounter’s involvement; customers agree to send their payments directly to the invoice discounter.
Factoring involves purchasing business-to-business (commercial) invoices at a discount. Factors “buy” and the client “sells” invoices. Clients are advanced funds on invoices due from creditworthy customers/account debtors, and advances range from 75% to 90%.
Whatever the source of capital, the banks have been very difficult on transportation companies. Wise executives need to consider all of their financing options.
Mark Borkowski is president of Toronto-based Mercantile Mergers & Acquisitions Corporation, a brokerage firm specializing in the sale of privately owned businesses. He can be contacted at email@example.com