How do you justify the expense of invoice factoring?

Invoice factoring is an excellent tool to fund the growth of your business for short to medium time frames if the economics make sense. Commodity sourcing usually does not work out because the margins are small but service industries, services mixed with sourcing, and high end product sourcing businesses have the types of margins that work well with factoring.  The basic concept of factoring is that you make a lot of points on a transaction, the factor makes a few points, and you use the factor’s money to make a transaction happen. Without the factor you would not be able to fund the transaction and would have to pass on new opportunities.

It all comes down to what your margin is on your transactions. As an example, if your gross margin is 30% and you get paid every two months then you are making a return over the year of 180% on your invested funds (6 times 30%). If factoring costs 1.75% per month then the factoring cost over 60 days would be 3.5% giving you a return of 26.5% on a transaction (30% minus 3.5%) or almost 160% over the year. Keep in mind that the actual return is much higher because you are using someone else’s money to make money.

On the other hand, if your margin is very small, say 5%, then invoice factoring does not make sense because the cost would eat up your profits. The key is that you are comfortable with the return that you will get using someone else’s money and in doing so helps move your business to the next level.

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Purchase Order Funding (also called PO Funding and Purchase Order Finance) is widely used by companies sourcing finished goods when their supplier requires payment before shipment. PO Funding can be used by a company when goods are directly shipped to their customers and the company does not take possession of the goods.  It is widely known that PO Funding is extensively used in some industries, such as the apparel industry, and also in funding larger import transactions. What is less well known is that PO Funding can be used to finance transactions as small as $30,000. There are specialized funders that we work with for these smaller transactions.

Typically the funder will advance 60%-65% of the purchase order amount. If the cost owed to the supplier is greater than this amount the client company requesting financing will make up the difference. In this case the total cost of the goods supplied will not be covered by the financing company but the majority of the cost will be.  As with larger PO Funding transactions, the supplier is usually paid with a Letter of Credit, particularly if they are overseas. The Letter of Credit protects both sides of the transaction and most suppliers use the Letter of Credit with their bank to get funding to produce the goods. It is usually executed based on an inspection of the goods before shipment from the supplier or at some agreed upon shipping point.

Also, smaller Purchase Order Funding transactions always have Invoice Factoring of the invoice for the transaction once the goods have been received by the end customer. In some cases there are two different funding companies, one providing purchase order funding and the other providing invoice factoring and often one firm provides both.

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A constant concern is how to finance the mobilization of a contract before the first invoice. Invoice factoring is the purchase of invoices for completed transactions, but funds are often needed prior to an invoice being issued. Typically contracts regulate how many and how often invoices can be issued and the usual process is allowing invoices for every 30 days of work. Many times there are expenses such as payroll or costs to suppliers that must be paid before the first invoice is available. Once the first invoice is factored the contract can become self financing.  However, getting to the first invoice can be a challenge. Below we have listed some alternatives to a traditional bank loan that may help in this situation.

Supplier Early Payment

One of the frequent issues with  contracts is that your supplier needs to be paid before you invoice your customer.  In many cases when the supplier is in the United States and the products needed are off the shelf we can pay the supplier before shipment. If the product is not off the shelf or if the supplier is over seas then Purchase Order Financing may be an option.

Micro Loans

Micro loans are sometimes available to provide initial funds for a project then once invoices are issued the invoices can be factored. This will require a relationship between the lender and the factor, in some cases the factor will pay the micro loan payment out of the factoring proceeds.

Cash Flow Loans

Cash flow loans are based on the average bank account balance of your company. Many companies can get a cash flow loan to help pay startup costs and then factor invoices once they are issued. From this point on the can be financed through invoice factoring

Using Other Projects to Fund the Startup

If you have other ongoing projects then one of the simplest ways to fund a new project startup is to invoice factor the invoices of another project. By releasing the funds in the other project earlier through invoice factoring you can access funds to jump start the new project.

These are just a few of the options available.  The benefit with most of these is that they can be combined with factoring as an ongoing process.  Feel free to contact us here and we’d be delighted to talk more about what options would work best for you.

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In support of the build up for World War II, the U.S. federal government put into place a set of rules in 1940 to assist in the financing of government contracts. This is commonly called the Assignment of Claims Act of 1940 and it allows for the transfer or making over by the contractor to a bank, trust company, or other financing institution like an invoice factoring firm, as security for a loan to the contractor, of its right to be paid by the government for contract performance. The Act is described in Federal Acquisition Regulation (FAR) 32.800 and sections underneath. This Act is still in effect today.

Under the Assignment of Claims Act, a company may assign monies due or to become due under a contract to a financing institution if the contract does not expressly prohibit assignment and the assignee sends a written notice of assignment together with a true copy of the assignment instrument to the Contracting Officer or the Agency Head and the Disbursing Officer designated in the contract to make payment. Amounts due for individual orders for $1,000. or more may be assigned.

This procedure is similar to the Uniform Commercial Code (UCC) assignment and notification of assignment in state law. In practical terms a difference is that with the UCC all invoice payments to a particular supplier are assigned to the factoring company regardless of which order or contract was responsible for the payment. With the Assignment of Claims Act, a separate assignment needs to be made for each contract to be financed even if they are in the same agency.

Since the Assignment of Claims Act has been in place for over 70 years it and its procedures are widely known by contracting officers and can be put into place quickly for contracts desired to be financed.

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In the current economy, businesses are looking for growth by pursuing lucrative government contracts. An essential part of winning and executing a government contract is how you will provide contract financing for the duration of it. Will your suppliers give you terms? Will you be able to meet payroll? How long will it take for the government agency to pay your invoice? Will you be able to complete the project without adequate cash flow? Will you be able to bid on multiple contracts without contract financing?

Sometimes cash flow issues do not begin until the contract is in progress. Factoring can help when you start performing on a contract or if it’s already underway. Factoring is fast, dependable, and can be put into place at any time during the contract. Whether you are a manufacturer, service provider, supplier or product reseller funding contracts is a simple process by utilizing factoring or accounts receivable financing. By financing contracts you can pursue additional and larger contracts.

Financing contracts by the federal government is different than financing a commercial contract. The Assignment of Claims Act which is a federal law which allows and specifies the procedures for assigning financial rights to invoices of government contractors and allows for payments on a contract to be made to a financial company as a third party. This allows a financial company such as ours to provide contract finance through accounts receivable financing and factoring. This method of funding contracts provides you with working capital throughout the life of the contract.

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