Understanding Invoice Factoring And The Cost Of Factoring Receivables

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Invoice factoring, other versions of receivable finance/asset-based financing in Canada, and the cash flow challenges that come with running a business remind us of that classic movie 'BEING THERE' starring Peter Sellers. Sellers, playing a ‘savant’ gardener in the movie says "and then we get spring and summer again”!

Most small business owners and medium-sized companies ( as well as large corporations !) know too well that clients prefer to take the longest credit terms they can get away with - in essence they are leveraging the line of credit you have offered to your customer - the reality is that many firms, in fact, can pay the invoice on time, let alone take an early payment discount.

In the movie he has a 'routine' in life - things are always the same. How then can Canadian business owners and financial managers break out of the constant cash flow challenge cycle? Receivable finance is one clear solution to that problem.

As an owner/manager, you know the drill - working capital is tied up in your A/R and inventory. Can invoice financing from factoring companies help untie that capital?

INVOICE FINANCE FIRMS PROVIDE IMMEDIATE PAYMENT TO YOUR BUSINESS IN EXCHANGE FOR A DISCOUNT ON THE INVOICE IN THE 1- 1.5% RANGE

Let's address that issue around the following key points: Exactly what is factoring, what are the benefits for your firm, what does it cost, and how does it work? That's a mouthful, but your understanding of these key issues could be the first step in your better understanding of one of the most popular methods of business financing today in Canada.

WHAT IS THE REAL COST OF INVOICE FACTORING

Factoring is the method by which you 'sell' your receivables as soon as you issue them. Selling anything gets you 'cash' and that's the core premise of invoice factoring. The largest, most successful corporation in Canada also offloads its receivables. They do that under a fancier method - securitization - at the end of the day, it’s the same thing - Selling you A/R constantly as you make sales to generate instant cash.

Do you have to sell your receivables? Of course not - you can wait 30/60/90 days for your customers to pay you - but you've been there already and that's not working!

So what then is the main benefit of factoring solutions? Essentially it's unlimited working capital in cash flow as you grow your sales. How can we say unlimited cash flow - well, simply because if you have receivables you will always have immediate cash for them! Cash flow problem solved!

KEY POINT - FACTORING RECEIVABLES IS NOT CALCULATED AS AN INTEREST RATE COST - IT IS A DISCOUNT PURCHASE OF YOUR INVOICE - THAT'S THE COST OF FACTORING RECEIVABLES FORMULA

Part of the problem in our clients' understanding of the cost of factoring is that they view it always as an 'interest rate', while in fact, it is an invoice factoring rate expressed as a fee /discount.

A/R commercial finance firms don't call it that - it is a discount rate. They purchase your receivable (either one, some or all of your invoices) at a discount - That discount in Canada is anywhere from 1-2%. The norm tends to be closer to 1.5 - 2%. So a best-case scenario is giving up $150.00 on a $10,000.00 receivable.

It's important to understand the factoring advance rate which is important in understanding the effective cost of factoring

A GOOD QUESTION TO ASK YOURSELF - WHAT IS THE COST OF NOT FACTORING / FINANCING RECEIVABLES?

So who in fact 'qualifies' for this type of financing? The reality is that if you have receivables you qualify! This type of financing covers pretty well every industry in Canada.

There seems to be a number of industries that are always using factoring - i.e. trucking/transportation, staffing, security guards, etc. - but don't be confused by that point - if you have a receivable, Canadian, U.S. or otherwise, it can be financed - or in our lingo 'sold' and 'cash flowed'. Even international receivables can be financed with a few modifications to the program.

ALTERNATIVES TO FACTORING

So are there alternatives to factoring? Of course, you can arrange more traditional financing via a bank, Canadian credit union, etc. However, that type of financing comes with stringent requirements, including solid financial performance, personal guarantees, other collateral, etc.

A/R finance facilities can be efficiently put in place - the process simply involves a basic application and the documentation to register the facility, in a similar manner that any bank would, i.e. a security agreement on your receivables, etc.

One other key benefit is facility size - at a bank-type revolving line of credit you have of course a limit, and you can't exceed that limit. That concept goes out the window with your receivable financing facility because your limit grows in lockstep with your sales and receivable investment. That's true unlimited financing!

It always comes down to cost and the overall pricing of your facility will depend on several factors - the overall size of your receivable portfolio, its credit quality, how your customers have paid traditionally, etc.

We recently met with a customer who advised us that their total all-in rate with a Canadian bank, including the rate and fees for all services, etc. was close to 11-12% when you factor everything in. Let's say your factoring rate was 2% per month. And let's also say you now had unlimited cash to pay suppliers promptly, take prompt payment discounts, and negotiate better pricing.

There really isn't in most cases that much more difference in factor pricing and bank pricing when you weigh in all the comparables. Business owners should also check out Confidential Receivable Finance - Click here for more info!

CONCLUSION

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

What is the real cost of invoice factoring/accounts receivable factoring? How much does it cost for accounts receivable factoring?

What are the costs associated with factoring?

Typical invoice factoring costs/ factoring fees from accounts receivable factoring companies in Canada are competitive and discounts are usually in the 1-1.5% range with respect to invoice factoring fees - The overall credit quality of your clients and the volume of business you finance are additional factors to lower that cost.

When they calculate factoring fees finance firms use different rate structures around fixed rates, variable rates, and rates associated with the discount.

The sale of the receivable is reflected as a credit to a/r - The cash received from the factoring company is a debt to your cash account. The financing fee/ factoring fee is recorded as a debt to financing expense.

What are the two types of account receivable factoring?

The two key types of a/r factoring for outstanding invoices are non recourse factoring solutions as well as recourse factoring. Non-recourse financing transfers the risk of collection and bad debt to the finance company - Normal recourse financing has the company carrying and managing its own credit collection risk and bad debt exposure.

' 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

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