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Factoring . . . Not for All Companies

Expert: Gary

Victoria asked:

When customers purchase our product, they often require a payment plan - this reduces our cash flow, monthly payments are nice, but if we had sold the product for cash, we could move forward a lot faster. Where can you find a source to purchase these sales contracts?

Gary answered:

This question is bigger than "a source to purchase these sales contracts". The essential symptoms reveal a shortage of working capital.

The first conventional financing aspects to consider, as a more permanent and, indeed, less costly alternative are:

  • Have you utilized appropriate trade credit, or even a loan or consignment inventories from trade suppliers?

  • Do you have an adequate line of credit from your bank, secured by accounts receivable margined to the ratio of 65 - 75% of these receivables (subject, of course, to standard ratios of debt to equity, working capital and profitability/cash flow?

  • Could you obtain a bulge facility from your bank, in the event that some of these sales exceed your monthly average of sales?

  • Do you need to increase the amount of liquid working capital by raising additional term financing secured by tangible fixed assets or by obtaining new equity investment?

If none of the foregoing alternatives is feasible, you could consider factoring (often known as invoice discounting). This source involves the sale of your account receivable to a specialized financial organization for immediate cash. Your proceeds are the gross invoice amount, less a discount of between 5 and 6%.

Typically, a sale of your account receivable transaction can be completed in one or two days, with the funds in your hands.  

There are usually a number of criteria to be met to complete a factoring:

  • Your customer must be well established and a low-credit risk.

  • There must be clear evidence of completion of your commercial transaction with the customer - e.g., a signed delivery waybill.

  • The customer must verify or acknowledge the indebtedness.  
Accordingly, it can be clearly seen that factoring can not be used by all companies for all sales invoices.

In summary, factoring can be an important financing alternative when the cash generated can be used to produce additional profitable sales. Most factoring organizations operate locally in major cities, since they need to work closely with the client to complete a transaction on a timely basis.

About the author

Gary A. Fitchett, CA, has been a financial consultant to small and medium businesses for 35 years, and is author of, Where to Go When the Bank Says No, published by McGraw-Hill Ryerson, and available in most bookstores. It provides practical real-world solutions to the many problems and concerns of SMEs, in relation to their financing needs.

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