Factoring Trade Receivables: Unlock Cash Flow

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TRADE RECEIVABLE FINANCING IN CANADA

You have decided to consider factoring financing as an overall business financing strategy.

Understanding Factoring Trade Receivables

LET'S DEBUNK SOME FACTORING FINANCE MYTHS!

Let’s explore the three things you need to know about factoring in financing your accounts receivables for those unpaid invoices in Canada and debunk some of the myths and misinformation that exist on this subject.

WHERE DID FACTOR FINANCE COME FROM?

The reality in Canada is that as a country, we came late to the factoring party for cash flow needs. Factoring started in the U.S. and Europe and has been established for hundreds of years.

As a result, the factoring that dominates Canadian business financing, both in business model and pricing, is heavily influenced by a small number of foreign firms in the asset-based lending area of Canadian business.

The history of factoring reaches back to ancient Rome, where producers and merchants employed a mercantile agent or “factor” to manage their sales. Records show that these factors continued to be used throughout the Middle Ages with increasing frequency.

SOME BASICS ON THE FACTORING FINANCING RECEIVABLES FINANCING SOLUTION

We should probably do a concise ‘primer’ on factoring to ensure we’ve got the basics in place. Factoring or receivable financing is the sale of your invoices or accounts receivable to a third party.

It is very dominant in specific industries, such as trucking and transportation, staffing, etc., but quite frankly, it is now prevalent throughout Canada in many industries.

We recommend that clients deal with Canadian firms when considering a factoring option.

Because this business financing is unique and misunderstood, we strongly recommend that you work with a trusted, credible, and experienced advisor who can guide you through what many consider the factoring maze.

So, let’s return to our three key areas: First, factoring firms vary in Canada by size, geography, and financial capability.

You need to align yourself with a party that is most suited to your type of business, the size of your receivables portfolio, and the ability to deal with any issues that come up on a one-on-one basis.

As we stated, it seems common sense that your best partner will be a Canadian firm directly representing your area.

WHAT IS THE COST OF FACTORING

We hate to say this, but the answer is that it depends. Receivable financing certainly has the aura of being expensive, and unfortunately, most clients we meet are always focused on the rate. A few key points must be made, so let’s be clear on this issue.

Accounts receivable factoring enables businesses to access immediate cash instead of waiting weeks or months for invoice payments.

This process allows companies to sell their receivables at a discount to a third party, alleviating financial strain and supporting working capital needs. It ultimately facilitates smoother business operations and growth.

First of all, factoring in Canada has a discount rate of between 1 -1.5% per month.

We use the term discount rate because the industry doesn’t view it as an interest rate; it views it as essentially a reduction in overall gross margin.

Let’s use a quick, straightforward example. Let’s say you have an invoice value on an invoice of $100,000.00.

Factoring allows you to receive approximately 90% of the funds ( the advance rate ) on an invoice the day you generate it.

(The balance, 10%, is paid to you when your customer pays) and out of that holdback comes, say a 1% discount fee to the factoring firm) the factor industry views 1% as a commission for financing your invoice.

THE COST OF CARRYING YOUR ACCOUNTS RECEIVABLE

If your customer pays in 30 days, a Canadian business can be forgiven by saying, "I paid 1-1.5% per month." That’s 12-18%% per annum, which is expensive. That's one reason invoice factoring /invoice financing can be your competitive edge in funding your business.

SOME KEY BENEFITS OF A/R FINANCING

One of the main points we can make when advising clients on a proper factor financing facility is that the funds you get on immediate cash conversion can be used to purchase inventory at a better cash price or to take advantage of the many 2% net ten-day discounts many suppliers offer.

Factoring receivables can improve cash flow by selling unpaid invoices for immediate cash.

If that were the case for all your businesses, we can say that you are recovering 100% of your financing costs via this strategy, plus you have unlimited working capital. That’s financial power and a great way to benefit from the factoring fee in your factoring facility.

SUMMARY OF KEY BENEFITS OF FACTORING

- Competitive fees due to industry competition from various financial institutions and commercial finance companies

- Offers the key benefit of the ability to pay key vendors and suppliers promptly while offering extended credit terms to key customers

HERE'S THE BEST FACTORING FINANCE SOLUTION - AND IT'S ' CONFIDENTIAL'

We alluded to the U.S. and U.K. firms that follow a very clear process for receivable financing for your firm—they send your invoice to your customer on your behalf, correspond with the customer, and call your customer for money.

But, and this is a large ‘but,’ did you know that with proper negotiations and the use of a proper advisor, you can negotiate and implement a CONFIDENTIAL RECEIVABLE FINANCING facility that allows you to bill and collect your receivables without long-term contracts while at the same time getting all the benefits of factoring—i.e., immediate working capital and cash flow?

KEY TAKEAWAYS

CONCLUSION - ACCOUNTS RECEIVABLE FINANCING

In summary, factoring can be easily misunderstood by some growing and small businesses, as can understanding its benefits.

Assess what you think is wrong or might not work with this method of financing, and develop a receivables financing strategy with the knowledge that you will not be making the mistakes of others who are less ill-informed.

FAQ: FREQUENTLY ASKED QUESTIONS/ PEOPLE ALSO ASK / MORE INFORMATION

WHAT IS FACTORING

Factoring, also known as invoice factoring/invoice discounting, is a financing transaction for small and medium-sized businesses to meet short-term cash flow needs. Factoring services, via Factored invoices, can be financed by a business as soon they're invoiced. This means that companies don't have to wait until later when money might already be due by the invoice date within the factoring process.

The factor or factoring company pays what's owed on the invoice - Invoice factoring companies take a ' factoring fee ' . Many factoring companies offer recourse or non-recourse factoring - the latter eliminating bad debt risk. An example of factoring in finance is a distributor who offers extended payment terms to clients but wishes to receive cash upon invoicing and delivery. Factoring is a short-term financing solution for businesses.

This method of financing is particularly beneficial for businesses that need to improve their cash flow quickly without taking on additional debt. By selling their invoices, companies can access funds almost immediately, which can be used to cover operational expenses, invest in growth opportunities, or manage unexpected costs. The factoring company then takes over collecting payments from the customers, allowing the business to focus on its core activities.

How Does Factoring / AR Financing differ from Traditional Financing Options?

Accounts receivable factoring differs significantly from traditional financing options, such as loans or lines of credit. Unlike loans, factoring does not involve borrowing money and does not incur debt on the balance sheet. Instead, the factoring company purchases the accounts receivable, assuming non-payment risk. This makes factoring an attractive option for businesses with limited credit history or those seeking to avoid debt.

Additionally, factoring provides a more flexible financing arrangement, allowing businesses to choose which invoices to factor in and when, giving them greater control over their cash flow. Traditional financing options often have strict terms and conditions, whereas factoring offers a more adaptable solution. Businesses can factor invoices as needed, ensuring they have the funds to maintain smooth operations and seize new opportunities. This flexibility, combined with the immediate access to cash, makes accounts receivable factoring a valuable tool for managing and optimizing cash flow.

WHO ARE THE 3 PARTIES IN A RECEIVABLE FACTORING FINANCE TRANSACTION

The three parties involved in a factoring transaction are the company that wishes to finance its receivables under a factoring contract, the debt factoring company that purchases and financed the accounts receivables, and the end user customer who is obligated to pay the invoice. Companies using confidential a/r financing solutions, aka 'non-notification,' can choose to bill and collect their receivables.

WHAT IS SPOT FACTORING?

Some businesses may choose to sell or assign only some of their unpaid invoices/accounts receivable at any given time, i.e., a specific invoice / specific invoices to a factoring company. This is known as ' spot factoring' and allows a business borrower to receive payment immediately on certain invoices without waiting for clients to pay the invoice/invoices. A financial institution such as a commercial finance firm can accommodate this type of financing.

ARE THERE DISADVANTAGES IN FACTORING?

Financing of accounts receivables is successful when invoices reflect products and services delivered without client disputes.

Financing costs will lower profit margins, so a/r finance solutions work well for firms with good gross margins - customers should be aware of any hidden fees

Commercial finance firms/factoring companies take security over the receivables they finance, as would a bank

Companies who sell to clients with marginal credit or who present collection risk will find it challenging to finance a/r

Terminating a factor facility requires a firm to retire all debt owing to the factoring company that has financed the receivables.

Some firms' clients who factor a/r may not wish to participate in this type of financing, although this is rare.

Businesses should only consider a/r finance when working with reputable firms and experienced business financing advisors.

How Does Accounts Receivable Factoring Work?

An example of debt factoring is when a business needs to access increased cash flow and working capital and chooses a debt factoring / ar finance firm to get an advance on accounts receivable that are not yet collected. The factoring company pays the business approximately 90% of the value of the invoice /invoices, and the remaining 10% is paid to the company when the customer pays, less a factoring fee - debt factoring is synonymous with invoice factoring/invoice discounting.

Factoring involves selling your unpaid invoices to a factoring company at a discount. The factor immediately advances a percentage of the invoice value and collects payment from your customers.

Factoring provides immediate cash flow, reduces collection efforts, offers flexible funding that grows with your sales and can help improve your balance sheet.

Factoring benefits B2B companies with creditworthy customers and longer payment terms. However, this financing option can benefit many industries.

Once approved, you can typically receive funds within 24-48 hours of submitting invoices, making it one of the fastest financing options.

Factoring fees usually include a discount rate (percentage of invoice value) and sometimes an additional service fee. Rates vary based on factors such as invoice volume and customer creditworthiness.

Factoring is based on your customer's credit, not yours. Unlike fixed-term loans, it provides immediate cash without creating debt and grows with your sales. Receivable factoring vs traditional financing is always an issue for businesses.

This depends on the type of accounts receivable factoring agreements. Some factors work behind the scenes, while others may directly interact with your customers for payment collection.

Many factoring companies offer flexibility in selecting which invoices to factor, allowing you to tailor the service to your needs.

Not at all. Many successful businesses use factoring as a strategic tool, and accounts receivable factoring enables firms to manage cash flow and fund growth better, particularly during expansion phases.

This depends on whether you have a recourse or non-recourse agreement. With recourse factoring, you're responsible for unpaid invoices. Non-recourse factoring shifts this risk to the factor.

Factoring companies typically assess the creditworthiness of your customers, your business's invoice volume, and the overall quality of your accounts receivable.

An Accounts Receivable Factoring company can potentially enhance customer relationships by allowing you to offer more flexible payment terms while maintaining your healthy cash flow.

Industries with long payment cycles, such as manufacturing, wholesale, and transportation, often use factoring to bridge the gap between delivery and payment.

' Canadian Business Financing With The Intelligent Use Of Experience '

Stan Prokop is the founder of 7 Park Avenue Financial and a recognized expert on Canadian Business Financing. Since 2004 Stan has helped hundreds of small, medium and large organizations achieve the financing they need to survive and grow. He has decades of credit and lending experience working for firms such as Hewlett Packard / Cable & Wireless / Ashland Oil

Factoring Trade Receivables: Revolutionize Your Business Cash Flow | 7 Park Avenue Financial

ACCOUNTS RECEIVABLE FACTORING IN CANADA