Yes, factoring does go back over 4,000 years to the Mesopotamian King Hammurabi. He was the ruler who established the world’s first metropolis, Babylon, considered the bed of civilization. The Mesopotamians are accredited with being the first to implement notes/borrowings on clay tablets between two parties. These clay ‘contracts’ indicated promises to pay; they were promises for future payments. This concept expanded trade and increased economic power for that time, setting a foundation for certain alternative forms of finance today.

Since then, factoring has evolved becoming a critical financial tool for doing business in almost every civilization that followed, the Romans included, who were the first to sell discounted promissory notes. The first documented form of factoring in the American colonies, however, was prior to the revolution.

Merchant bankers in Europe gave the American colonists advances for materials, allowing the colonists the ability to harvest their lands. Raw materials like cotton, furs, tobacco and timber were shipped from the colonies to Europe. Factors during these colonial times advanced against the accounts receivable of these companies. This practice became very beneficial to the colonists, as they didn’t have to wait for the money to begin their harvesting again.

Later, during the economic revolution, factoring became more concentrated on the issue of credit, as factors began assuring payment for certain clients (today known more as non-recourse factoring). Before expanding to varied business types after the war, factoring specifically catered to the textile and garment industries in the United States.

By the 1960s and 1970s, an escalation of interest rates and tighter credit spawned a new interest in the factoring market, with a number of private factoring companies coming into existence. By the 1980s, further rate increases combined with new regulations within the banking industry caused many small businesses to seek alternative sources of funding outside of traditional banking. It was at this time, factoring became a more popular option for many of these companies.

As many of you know, factors make funds available even where banks cannot often do so; typically, factoring companies focus on the creditworthiness of the customer (debtor). In contrast, the fundamental emphasis in a bank lending relationship is on the creditworthiness of the company itself, not that of its customers.

Factoring is a financial transaction wherein a company sells its invoices/accounts receivable to a factor at a discount. In exchange for this, the company receives immediate working capital. Three parties are involved in the transaction: the factor, the company seeking financing and their customer (the account debtor). The sale of the accounts receivable transfers ownership of those invoices to the factor, at which time the factor obtains the right to receive the payments made by the customers.

Today’s factoring still focuses on advancing funds to small to mid-size, rapidly growing companies who sell to larger, creditworthy customers. Factoring is among one of the most effective and efficient forms of financing utilized by businesses. It immediately improves the cash flow of a business.

In addition, today’s factor offers other support services for their clients including providing credit checks on new and existing customers, sending monthly statements to customers for payment, performing collection calls, processing and maintaining history on invoices and customer payments, and providing reporting for this information, typically with online access for the client. Some factors even provide additional financing services for their client companies.

After all of that, the only history question from Factoring Jeopardy that this actually addressed and answered: Who is Hammurabi? I no longer remember the other questions… maybe some of you do and want to comment…

Wishing you success. The Factor Guru.

This has been an amazing year so far for factors. I say amazing, but I could probably come up with dozens of adjectives and each would be fitting.  Words like challenging, tough, and busy come to mind too.  This year is different though; I have observed something markedly different than in all my history in this business, which is the huge amount of exposure our industry has enjoyed.  Never before has the word “factoring” appeared so many times in news searches on the internet.  Sometimes the stories are good, you know the ones where factoring is seen as a positive form of finance – other times the stories aren’t so great, like fraud occurring either within a factor’s portfolio or those rogue entities that raise money ostensibly for the purpose of purchasing receivables to only use the funds for anything but factoring.  CIT’s troubles alone have brought factoring into the limelight.  While I truly wish the best for that company and who knows how that will all end up, I suppose I am grateful that more and more of the population has heard of factoring just from reading about CIT in the news.

I have the pleasure of working with multiple factoring companies on a variety of projects – and in so doing have gained a very unique perspective on the state of the industry today – guess what, there are many new deals being booked daily all over the place!  Those factors who have strong underwriting and portfolio management standards as well as their own capital and access to liquidity are finally able to grow their client base simply because other forms of finance are not available.  On the other hand, there are factoring companies who struggle with access to liquidity and declining sales volumes because their client’s sales have decreased.  There are also start up factoring companies opening all over the country as they see factoring as a good business to be in – as long as those folks are seeking out education and assistance and respect established standards, they should be able to do well.  Unless every single factor I’ve been talking to is fibbing, they’ve all been busy putting on new deals – and don’t see their pipeline dwindling any time soon.  Nope, no horror stories here.

A factoring company (just like any other business) wants to make a profit at the end of the day.  This is no easy task when you consider the amount of overhead it takes to run a factoring operation.  Salaries, Credit Expense, Cost of Funds, Rent, Due Diligence Expense, Lock-Box Fees are just a few of the expenditures a factor has.  The smart ones also put a little away each month to build up a loss reserve should the inevitable occur.  To the average person on the street, when they see what a factoring arrangement is priced at, may feel it is exorbitantly high, but when you take away the actual costs to provide this service, you’d be surprised at how little of those fees actually make it to the bottom line.

All that being said – factors have to charge what they charge because factoring is labor intensive and expensive to operate.  If the factor just purchased invoices and advanced funds, they would be out of business very quickly – that translates into fewer companies providing this critical form of finance – not a good thing for the general business environment.   That would be a horror story.

I think that many factoring companies (at least those that I deal with and talk to routinely) are in this business both to make a little profit and because it’s rewarding to help companies survive by providing working capital.  No one I know is in the business of gouging their client base. Moreover, it takes effort to find a client, to perform due diligence confirming the factor can make a difference for that company and then to bring the client on board to provide financing.  We all strive at that point to keep the client active for as long as possible – the average being 18-24 months.  I recently spoke to the head of a factoring company that said they’ve been able to keep their average client to up to 30 months!

Factors actually work hard at the collection process to help keep receivables turning so that the costs of factoring remains as low as possible for their clients.  These aren’t heavy handed collection tactics, merely good old fashioned solid receivables management techniques.  The result is that the client also maintains a healthy bottom line.  Client’s who grow or mature enough to be able to qualify for bank financing make this all a win-win situation.

When I hear of “client horror stories,” I am disheartened by the hyperbole.  I guess I come from the side of the fence that a client horror story is one wherein the client  figured out the perfect fraud and then absconded with big piles o’ cash.    While there is press that suggests that factoring companies are Good, Bad or Evil – these are all emotional terms – working capital shouldn’t be emotional.

If a business needs a factor they can look to any number of resources to find the best arrangement possible.  Price and Structure should not be the only deciding factors (pun intended).  One company may offer a low rate but then require monthly minimums and a term of one year, while the next company may offer a higher rate with an easy out and no minimums.  Some companies even offer programs that adjust with the client’s sales volume.  If you spend the time to understand the differences, you’ll probably find that in the end most offers are relatively equal in costs (plus or minus some basis points).  So if all terms are equal, what can a business seeking a funding source do?

The answer: get to know the factoring company. Ask for client references, and then… actually call them.  Does the factor have a history of taking care of their clients?  How long does the average client stay with the factor?  Is it only three months?  Or is it two years?  What other services does the factor provide? Same day funding on schedules received by noon or does funding take 48 hours or more (routine funding not the initial funding)?  Does the factor understand your business?  How well do you relate/communicate with representatives of the factoring company?  Is the company secure – do you think they will be there when you need them?  Are they in the same time zone as you, and if not does it make a difference (to some it might – to others it won’t).  Are you working directly with a funding source or through a broker?  How do you know the broker is really looking at the best deal for you?  There are so many other issues besides price alone!  If sales volumes can be maintained, maybe the smaller fee with minimums is the way to go. If not, then the higher priced deal may look more attractive.

If I go back to how I started this article, I was shopping… so, look at it this way, when you buy a plain white shirt from a low cost retailer, you probably don’t expect for the shirt to last very long – seams unravel, it gets stretched out, etc…  Buying a similar shirt from a more expensive retailer probably means the shirt will cost more, but the stitching will be different and the fabric might be stronger, and generally speaking, that shirt ought to be in your wardrobe for much longer than the less expensive one.  Which do you buy?  That’s a personal decision. For me, I’d spend extra just to know I would have something of quality… something that would last.

One more thing, you know that factor that quotes a lower rate but then imposes minimum volumes – well, I’ll be willing to bet that can be negotiated.  The negotiation however probably won’t be that the factor will maintain the same low rate without minimums – they simply can’t afford to do business this way.  In order for any transaction to work, it has to benefit all parties – everyone needs to “win.”

It’s a shame when clients don’t fully understand what they’ve signed up for though.  I was taught early on to never sign something that I either didn’t understand or didn’t agree with.  I make it a matter of practice to fully read any document I need to execute and if something isn’t clear to me, then it’s my duty to learn more before signing, and that’s just personally.  Shouldn’t a business owner follow the same rule?  Imagine signing a three year lease and then three months into the lease deciding that you no longer wish to rent the space.  There will be penalties from the landlord to break that lease, why should factoring be any different?

So, I don’t have any horror stories, even though Halloween is near.  Factoring works because those providing the capital know what needs to be done in order to protect that capital, and clients understand that having access to that capital comes with a price. Clients need to look at their business critically to determine if factoring works for them or not.  The business that has very low margins probably shouldn’t factor; the businesses that have some room to absorb the costs of factoring almost always benefit by having the working capital to sustain and grow their operations.  Most factoring companies probably have tons of success stories, and even those that do will have experienced a relationship that did not end well.

I think it’s up to us as an industry to maintain how positive factoring arrangements can be for everyone – not just the factor and not just the client.  This is the business we’ve all chosen to be in and I’m proud to be a member of this community.  I don’t want to dwell on situations that I’m not directly involved in, and I try not to lay blame when the facts aren’t public.  I’d rather shout out that factors are here to serve the businesses that need our funding, and we’ve got the capital to be able to help.

Let’s all take advantage of these current economic times by continually promoting that factoring is a great form of finance!  Lift up our industry for the greater good.

How is the sale requested from the debtor?

In any industry, each party typically can evidence the ‘sale’ that generates an account receivable or invoice. Generally, a customer (Debtor) will ask the Prospect (Client) to perform a service or provide goods. This request can be in several formats such as verbally, a contract, work order, services agreement, purchase order, etc. This underlying agreement, when available (and yes, it’s available and does exist), dictates the terms of the sale. Pay special attention to those documents that refer to another agreement, the other side of the purchase order, or a website to print their underlying terms and conditions. You may find this information ‘enlightening’ when you are contemplating purchasing invoices and understanding the true sale arrangement.

How is the sale completed?

Once the service has been completed or the goods have been delivered, the Client can usually show that they did provide this service or deliver these goods. This can be in the form of a timesheet, delivery ticket, bill of lading, third party delivery, etc. There should be a way to show the completion of the sale, such as a sign off of the work completed, delivery documentation, etc…

When does a company invoice?

It is at this point that an invoice is usually created and sent to the Debtor. Remember, the invoice is not what dictates the terms and conditions of a sale. It is a reminder of payment for the services or goods delivered. Understand too that just because the Client prints the invoice off their system does not mean a completed sale has occurred or that the customer will pay. For example, a Client may invoice when an order is shipped; however, the goods may need to be inspected (as per those terms and conditions you found on their website) before payment can occur.

What do I ask for then?

Many times, it is easier to ask the Client how they do their billing. What do they receive letting them know their customer wants to order something or have something done? What do they get when it is completed? What does their customer require for payment? Sometimes, it is better to ask these open ended questions to gain a better understanding of the Client’s overall billing process. For example, if you just ask for the purchase order, it may not include the original underlying contract that exists.

Many factors will request a sample of the Client’s billing during the due diligence phase. Often times, Clients tend to provide a sample that doesn’t match as they are just pulling the closest information they can find on their desk (meaning, you may receive a work order for one sale, an invoice for another and a delivery ticket for another). However, it is important to be able to review an entire sale from beginning to end. Try to have the Client provide you with an invoice and all the backup relating to that ONE entire sale or order.

Once you have a basic understanding of their sales process, new questions may arise as you review this paperwork. Understanding that paperwork is critical, so ask the Client whenever in doubt or whenever something is not clear… it is better to know before you fund an invoice than when you are trying to collect on that invoice.

It is also important to remember that each industry is different and may have various types of documentation specific to their industry. But, we’ll leave that discussion for another day…

Wishing You Continued Success. The Factor Guru.

Generally, these sales are for completed orders (for goods delivered or services rendered). This includes a variety of industries including, but not limited to, manufacturing, staffing, transportation and logistics, distributing, importing/exporting, medical and healthcare businesses, oil and gas, consulting, IT and technology, services, construction and many others. Some factoring companies will finance progressive or milestone billings, although this tends to be the exception more than the normal course of operation.

Once the invoices have been sold to the factor, the client receives an ‘advance’ of anywhere from 50% to 95% of the invoice, with an average advance rate more likely at 80% to 85%. Advance rates depend on the industry in which the client operates, billing practices of the client, and payment patterns of the account debtors. For example, a client in the construction industry may have offsets for subcontractor payments, retainage, and other industry related offsets. In this case, a lower advance rate may be warranted. On the other hand, staffing and transportation businesses tend to have fewer reasons for non-payment of an invoice, resulting in a higher advance rate being offered.

Assuming an 80% advance rate, the factor would then retain a 20% ‘reserve,’ which would be released back to the client once the account debtor has made payment to the factor (less the factoring or discount fees that have been earned and/or accrued).  Before these payments are made to the factor, this reserve is often called an ‘accrued’ or ‘escrowed’ reserve. Once the payment has been received, however, this reserve becomes a ‘cash’ reserve, assuming full payment of the invoice (or at least the funds advanced plus fees) has been received. Factors may hold cash reserves for other potential invoices that are aging out on the factor’s books, have known disputes, or where other credit criteria may deem holding such cash reserves necessary.

Factoring can be a useful tool to companies seeking capital or needing to increase their working capital cycle. Stay tuned for more details on the inter-workings of factoring and its importance to helping companies manage their cash and their receivables while focusing on the growth of their business.  

For reference, you may want to read Wikipedia, which has a good general overview of factoring including a brief history. About.com also had some other reference information on the benefits of factoring.

Happy reading. The Factor Guru.