"Should we consider Financing Tools such as A/R factoring, discount checks, etc., as a normal rule of business or only for temporary cash shortfalls?"
This question was asked at a recent webinar, now available on-demand:
"Essentials of Working Capital Management: Trade Credit & Collections"
Please add your thoughts about it below. Thanks!
I'd use the items you mention -- factoring, et. al. -- on a temporary shortfall basis, or, more likely, when you need to collateralize a short-term loan. Factoring and check discounts are expensive forms of short-term cash and are usually tapped by companies with sweeping seasonal differences. Overseas, you may have to effectively pledge assets, such as high-quality receivables, to get decent rates on debt.
The operative word here is "tool." Invoice factoring is a commercial finance tool and it is SOP for certain circumstances.
Factoring is considered a bridge to conventional banking. It is meant to be used temporarily (which could be 6 months to a year) in order to strengthen a balance sheet for a company to qualify for the type of loan that will take it to the next step.
The cost of all types of financing is relative to the situation a company finds itself. If a company is able to perform on new and larger contracts because they know they can get paid as soon as they deliver their service or product, then this tool works for them.
If a company qualifies for a bank loan that really doesn't meet their needs (it's too small a facility) then the result can be a crushing inability to access any other outside working capital without first paying off that loan.
The key when using factoring is to find a factor who generally funds businesses in your particular industry. There are a handful of vertical markets where there are factoring companies who only work within that industry (example; transportation, construction, healthcare.)
Factoring companies generally do not consider "one off" transactions or distressed situations as a preferred part of their business. They are more apt to avoid those circumstances.
I would say special circumstances only. As Gary says; if you need very short term financing and know you have an influx of cash coming in, it is a good tool. If you have to rely on factoring all the time then (in my opinion) you have some other business problems that need to be dealth with.
Factoring is a tool that is used nationwide in numerous industries including wholesale sales, trucking, staffing, medical, oil and gas, agriculture and selling products and services to the government. One reason is to improve cash flow. Another reasons are for reduction or elimination of
Factoring is not limited to the SME market; some of the largest companies with billions in sales use a factor.
There are two basic types of factor agreements, recourse or non-recourse. In simple terms; a recourse agreement says that if the factor is unable to collect the invoice it has purchased and advanced (typically 85% of total); they will return the invoice back to you to collect. A non-recourse agreement says once an invoice is approved; the collection of the invoice is the factor's responsibility and there is no risk to you. In many industries using a factor increases the probability of the invoice being paid because of the clout they carry.
In either agreement the factor checks the credit and determines if the buyer is credit worthy for the amount of the invoice. Factors usually have much more current payment trade data and experience with most buyers/companies than an individual company would.
Spot factoring is used for special circumstances. However there is no guarantee that a spot factor will buy the invoice(s).
The rate (3% for the larger and more established factors) is comparable to what merchant processing companies charge for credit card transactions.
Purchase order financing is also a tool that should be considered if an order much larger than usual is received or if there is a cash flow issue.
Choosing to use a factor depends on a company's risk tolerance, cash flow needs, margins and who their clients are and where they are located.
