Often a company’s quickest method to grow to the next level is by obtaining a contract larger than any previous ones it has performed or completed. This method is desirable since it causes natural growth in a manner where there is experience, history, and a proven track record. These contracts can be with government agencies – federal, state, municipal or with publicly held or private companies. The easiest way to increase a company’s contract volume is to gradually take on more business with agencies or companies with which it’s already conducting business. However, there may be many lucrative contracts with companies or agencies where there is no previous history. In either situation, factoring can help.

Invoice factoring remains one of the fastest and flexible forms of finance. With factoring, everything focuses on the invoices being issued to a creditworthy client. Advances are made to the business as invoices are issued so the owner doesn’t have to wait 30, 60, 90 days to get paid. Since it is not a loan, it does not appear on the balance sheet of a company. By factoring you gain access to your own funds faster.

Advantages of invoice factoring:

Fast – Available in two weeks or less.

Creditworthiness – The credit shifts from the small business owner and company to the creditworthiness of the entity with whom it’s doing business. A factoring company will check the creditworthiness of that entity to give the business owners confidence in their business relationship. This makes it an excellent option for new businesses or start ups.

Alternative to Equity Lending – No ownership or equity stake is sacrificed therefore allowing owner(s) to retain full ownership and decision making abilities.

Cash Flow – The immediate positive effect on cash flow allows the small business to pay its bills faster therefore stabilizing its credit Often vendor early payment discounts can be utilized.

Grows With the Business – There are no limits with this financing as long as invoices are being issued.

Unrestricted Use of Funds – Funds can be utilized for any purpose including payroll, supplier expenses, taxes, marketing and advertising, ongoing expenses, even expenses incurred while bidding on new contracts.

Outgrown Bank Facility – If a company has outgrown a bank facility, factoring can extend credit beyond the original limit, often by paying off bank debt.

No Long Term Commitment – Traditional lending can often extend out for years with tedious monthly payments. Factoring can be set up on a selective basis with no time or volume commitment or ongoing with a minimal time frame and volume amount.

Time Constraints – Frees up valuable management time for owner(s) since credit facility is in place.

Readily Available – Factoring offers a dependable, continuous source of cash to all size businesses without having to reapply for loans or lines of credit or seeking out new investors.

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Many types of companies can benefit from the use of invoice factoring. As long as a company is doing business to business or business to government (federal, state, county, city) and issuing invoices for completed work, factoring is a financing possibility.  Most companies that utilize invoice factoring have a staffing element and therefore a payroll to meet. Often there is a gap between payroll and invoices being paid. This creates a cash flow issue since working capital is tied up in unpaid invoices. Factoring releases this capital.

The companies that benefit most from factoring (but are not limited to) include the following:

• Professional Services
• Architects, Engineers, Consultants
• IT Companies
• Medical – hospital, nursing home, home care
• Security Guard, Alarm and Surveillance Companies
• Staffing – administrative, accounting, temporary, etc.
• Janitorial – including general maintenance, carpet cleaning, construction, office maintenance, and pest control
• Court Reporting Agencies
• Translation Companies
  Printing and Graphics Companies
• Manufacturers
• Distributors and Supplier
• Garment and Textile
• Import and Export Companies
• Transportation, Freight
• Contractors and Suppliers

Their margins are such that using invoice factoring is an excellent way for them to fund profitable growth.

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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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In factoring, the credit decision is focused on the accounts receivable of a company because it is the collateral in the transaction. Factoring is governed by the Uniform Commercial Code (UCC), which are the laws that have to do with business transactions.  This includes debts owed by one business party to another. All 50 states, Washington D.C., and most provinces in Canada have adopted the UCC.

A key aspect of factoring is the Notice of Assignment. This is a letter issued by the factoring company to their client’s customer (the debtor of the invoices). The specifics of this letter are dictated by the Uniform Commercial Code. It instructs the debtor to remit payment to the factoring company for payment of all invoices that the client issues. When a debtor company has received a Notice of Assignment they are obligated by the UCC law to pay the factor all invoices issued by their client until they have been notified by the factor that the funding relationship has ended.

Payment directly to their client instead of the factor does not remove the obligation under the UCC law to pay the factor. Most factors send the Notice of Assignment to a senior person in the general finance or accounts payable department of their client’s customer and will work with them to set up correct remittance information.  In addition to providing access to capital for businesses, factors do a quality or verification of invoices to make sure that the product or service has been delivered acceptably and will be paid as per the contract. This is done very unobtrusively usually by email, online, or even verbally.

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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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Not every factoring solution is the right fit for every company.  Say for instance you’re a landscaper and most of your work takes place in the summer time.  Would you want to sign an agreement that impacts your business year round?  What if you have a staffing company with consistent monthly invoice amounts and you want a more competitive rate?   Below we have explain the main differences between selective and comprehensive invoice factoring and how each can help in these situations mentioned.

Selective Invoice Factoring

With this you can choose which accounts to factor and which invoices from the chosen accounts to factor. There typically  is no minimum dollar amount required and no required time frame to factor. This type of factoring works well if your business is seasonal, have short term needs for funding or if you win periodic contracts that require cash flow.   In this case you may not want to make commitments because you need varying amounts of money each month and even have months when you do not need funding. Also, many firms are not comfortable turning over their entire back-office to a factoring firm as is required by comprehensive invoice factoring.  The factoring rates are slightly higher than if you make time and dollar commitments but the flexibility is much greater.

Comprehensive Invoice Factoring

With this type of invoice factoring you commit all the invoices for all customers.  You are required to commit to minimum monthly amounts to be factored and are required to commit to a contract for a set time frame, usually a year. In return you will receive lower factoring charges per the value of invoices factored. This type of invoice factoring works best if you have won a large extended contract or if you have an established set of customers with a predictable amount of business over a period of time.

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A service oriented company’s primary expense is payroll and expenses related to this, such as insurance and worker’s compensation. This is the case for most staffing companies as well other service oriented companies such as security guard, information technology, pest control, management consulting, and janitorial companies.  Invoice factoring and other types of accounts receivable finance are particularly well suited for these types of companies to finance their business. There are key characteristics of this financing that make it appealing for these businesses and include many practical options.  Below we have listed some of these.

Speed to Obtain Financing. Lines of credit can be put into place as quickly as a week and larger multi-million dollar lines can be in place in as little as two or three weeks. This is compared to other types of funding that take at least a month or longer. Timing is critical for service oriented types of businesses because many times they are experiencing rapid growth from winning a single large project and they need payroll funding quickly.

90% Advance Rates. The margins on many of these businesses are squeezed and higher advance rates are needed to cover payroll and other expenses. Other forms of lines of credit may be available but typically advance a much lower percent of the outstanding accounts receivable than does invoice factoring.

Funding That Can Grow Rapidly. As projects are added, the invoice factoring line grows in size and can provide higher advance rates. Other traditional forms of credit typically are capped at a certain amount until there is substantial history (often a year or more).

Over-advances. In some cases there are startup expenses for projects needed to be paid before the project has any related accounts receivable. With overadvancing, money is used to pay these expenses. An example is inital payroll before first invoice is issued, another is a need to purchase and uniforms or equipment at the beginning of a project.

Industry Knowledge. Speed, flexibility, and industry knowledge are key to invoice factoring in being responsive to their client’s rapidly changing needs in the service oriented industries.

In summary, when invoice factoring is put into place correctly, it is a key enabler for payroll funding and other expenses of service oriented companies.  This helps to ensure the success of these companies and allows them to grow rapidly and profitably.

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In many cases a company has a bank loan or line of credit but the amount is not enough to fund new opportunities for the company. When the bank is approached about increasing the debt, if they can’t substantiate the increase, they will refuse to extend any further credit. Invoice factoring is an option to finance the growth but since the bank debt is less expensive than invoice factoring costs, it benefits a company to keep what bank financing it has in place. However, the cost of lost profit from turning down additional work can be significant.

The best scenario would be to factor the new projects while keeping the existing bank line in place. In doing so you maximize the amount of bank funding and use invoice factoring for business growth. If your bank debt is unsecured, meaning that a financing statement (UCC1) has not been filed, then establishing a factoring relationship is straight forward. The factoring company will need a first position UCC1 on the accounts receivable being factored. If the bank has secured the debt by filing a UCC1 on your company then an agreement called an inter-creditor agreement must be established with the bank. This agreement gives the factor first position on invoices and the bank keeps a first position on all other assets. In some cases the bank will require that the factor pay them the monthly amount owed on the loan first before funds are given to you from factoring the current invoices.

In cases where the bank will not sign an agreement and there is a bank UCC1 filed it will be necessary to buy out the bank debt completely or in some cases buy down the debt to an amount where the bank removes the UCC1 filing. As above, this will free you to move forward with factoring. In this latter case you still can take advantage of some level of bank funding while using factoring selectively to grow your business profitably.

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A major expense for IT companies is personnel.  Many small businesses don’t have sufficient working capital to cover the payroll or contractor expenses. These expenses are due typically weekly or every other week while payment of invoices doesn’t happen for at least a month, many times much longer.  The result is that the size of the contracts and the number of contracts that an IT provider can take on is limited.

Government contracts are very popular these days because of the economy.  Government contracts can be large and they can span  several months.  Because of this, the cash flow required can be large and small businesses are limited or totally locked out of pursuing other contract opportunities.  In many cases, a small business IT provider will subcontract to a larger prime government contractor such as Raytheon, Lockheed Martin, or Boeing.  In this case, the small business is still limited because their cash flow can be tied up by both the government and the prime contractor.

Traditional sources of funding just aren’t responsive these days to the needs of small businesses.  The requirements to get funding have gone up tremendously and many small businesses are locked out from this source of funding.  Even mature small businesses find that their working capital is tied up in other projects and they have to turn down business that they could do otherwise.

There are readily available sources of financing for small IT providers on government contracts.  Government contract factoring can be the financing solution that is the difference between having to turn down a contract and their pursuing a profitable opportunity.  Government contract factoring is factoring focused on contracts at any level of government.   Most levels of government have processes in place that make it easy for alternative financing firms to provide lines of credit for small businesses providing products or services to the government entity.  These are based on the size of the billing to the government so the line of credit is uncapped and will work with any size project no matter how large it is.

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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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