So many authors, including myself, have written about the benefits of invoice factoring explaining how we help businesses in need of working capital.
Just type something like, “benefits of invoice factoring” into your favorite search engine and you will find pages of articles telling you how factoring works and why it is the best solution for your business.
As the owner of a factoring company I can definitely say that factoring is an extremely useful tool to help businesses grow by unlocking cash in the form of an account receivable.
But is factoring a one size fits all tool for all businesses to achieve growth?
As a featured speaker and panelist at small business workshops over the last several years, I’m fortunate to be given the opportunity to speak directly to business owners. Typically, when presenting at these workshops I am joined by a traditional banker and a lending specialist from the Small Business Administration. As the person representing the factoring industry they usually give me the coveted title of “Alternative Lender”.
Solutions from an “Alternative Lender”
We are each given approximately thirty to forty-five minutes to present to the group on how our industry can help them with their business challenges. When it comes time for me to present I explain that factors are not lenders but rather purchasers of invoices.
It can be confusing since many factors charge on a time based fee and in the case of recourse factors the invoice is required to be repurchased after a certain amount of days outstanding.
The factoring challenges with slow paying customers.
One of the first comments I usually get from business owners is that they are interested in factoring but would only like to fund their customers who are slow payers. I always caution that factoring companies are not collection agencies and most prefer to stay away from slow paying customers for several reasons.
Let’s assume your client has just given you a $10,000 invoice with one of her slow payers.
For simplicity purposes we will assume the factor has advanced 90% and will be charging a 3% fee for every thirty days outstanding.
We will also assume that the payer of the invoice usually takes 120 days to pay.
So let’s do the math-you as the factor have advanced 90% on $10,000 leaving you with a $1,000 reserve. If the invoice has gone 120 days outstanding that equates to a $1,200 fee (10,000 x 3% x 4).
If you only have $1,000 in reserve and are owed $1,200 then you are upside down by $200 on this transaction.
There are remedies in a situation like this such as withholding advances on future invoices or deducting rebates from other invoices. Another possible solution can be to lower the advance allowing for a larger reserve on future invoices.
However, our position for slow paying account debtors has always been to question why it takes them so long to pay.
Is the payer so financially unstable that they need to hold on to their own cash?
Is the problem with your client where they are not property billing even though the invoices were verified?
It’s kind of ironic that experience has taught us that some of the most financially sound corporations are notorious slow payers. With large companies there is usually a myriad of red tape they need to go through to get a payment approved. Fortunately many of these larger payers now utilize online account payable systems where we have the ability to simply log into the system, see the approval and date the invoice will be paid.
Another case where factoring does not work is when the client refuses to allow you any contact with his customer.
I look at this situation as more of a common objection. For all of you new factors I highly recommend that you get a signed notice of assignment which includes signatures from both the client and the account debtor.
A “Notice of Assignment” is generally a written instruction to the client’s customer that the client’s accounts receivable have been assigned and is payable to the factor. This is an extremely important document for factoring companies. This document protects the factoring company in the event a payment is accidentally sent to the client instead of the factor.
Even if the client skips off with your money, this document ensures you are still owed the funds from the client’s customer. Hopefully, you will never have to enforce this notice but it is imperative you have it as part of your requirements before funding. For further reading on this subject see our April 16th, 2012 article, “The Factoring Business Notice of Assignment-Never Fund Without It”.
Also, another thought to keep in mind is how will you verify your client’s invoices if you have no contact with the payer? Sure, you can skip some steps and do what some people in the industry call non-notification factoring. For our money that is out on the street, we prefer to take every step that helps to minimize the risk in any way.
These are just a few examples where I feel certain situations are not the right fit for factoring. At many of our workshops the business owners cannot factor with us simply due to the fact they are new and haven’t invoiced any clients. At this point I tell them to be proactive and always try to remain one step ahead of the game in managing their business.
Now if I can only figure out a way for them to give me a cooler title than “Alternative Lender”.
This article was written by our president Don D’Ambrosio and originally published in Factoring Investor on June 17, 2013.
Don D’Ambrosio is the president of Oxygen Funding, Inc., an invoice factoring company located in Lake Forest, California.
For more information, he can be reached at firstname.lastname@example.org or you can visit his company’s website oxygenfunding.com