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Factoring A/R Examples

Businesses of all types and sizes can factor their accounts receivables as a means of raising cash to maintain their operating expenses. This financial tactic is commonly referred to as “invoice factoring.” Any business that sells products or What is accounts receivable factoring?services to customers is a candidate for taking advantage of factoring accounts receivables. Invoice factoring companies purchase outstanding invoices from businesses with credit-worthy customers in exchange for cash. The instant influx of cash allows  businesses to continue operating smoothly and also to further advance their product development strategies.

Businesses that work successfully with invoice factoring companies to factor their invoices typically have the following characteristics:

•    They provide a product or service – – usually to commercial customers.
•    Their commercial customers must be credit-worthy.
•    They must have a profit margin that is higher than the fee that invoice factoring companies will charge.

Businesses That Most Commonly Utilize Factoring
Businesses in any industry can technically be excellent candidates for factoring their accounts receivables, but the most common types of businesses to utilize invoice factoring are as follows:
•    Businesses that manufacture small or large products
•    Businesses that specialize in wholesaling small or large products
•    Businesses that distribute small or large products to other businesses
•    Businesses that focus on providing all types of services

Specific examples include the following types of businesses:
•    Staffing Agencies
•    Construction Companies
•    Trucking Companies
•    Businesses That Handle Government Contracts

Why Businesses Choose to Factor their Accounts Receivables
The reasons behind a business’s need to factor its invoices can be vary, but the most common motivations include:
•    Cash flow problems due to customers’ delaying the payment of their invoices
•    Higher than normal expenses because the company is a start-up
•    Additional expenses associated with the development of a new product or service
•    Extra costs associated with a significant advertising or marketing campaign
•    Out of the ordinary cash flow issues due to seasonal fluctuations
•    Sudden and drastic changes in the economy
•    The business is does not  qualify for either a short-term or a long-term loan from a bank

Who Runs Factoring Companies?
Factoring companies can be operated either by a private company or a publicly held financial institution such as a bank. The importance of who runs factoring companies is not necessarily as important as how the factoring companies are run. Experience matters. Factoring companies that not only have adequate cash on hand to purchase invoices but also are skilled at collecting the amounts due on the invoices they purchase are the most successful. The ability for factoring companies to have a professional and successful working relationship with the businesses from which the invoices originate is also vital. The best scenarios involve businesses with highly reliable customers who are certain to pay their outstanding invoices in a timely manner to the invoice factoring companies that purchase them.

Invoice Factoring Example
It can be difficult for business owners who are not familiar with the concept of invoice factoring to fully understand this business tactic without being provided with real-life examples of how similar businesses use and benefit from invoice factoring.

Following is an example of how invoice factoring works in the manufacturing industry:
General Patio Furniture, Inc., a manufacturer of patio tables and chairs, has been asked by a large department store to produce 10 patio sets in two weeks. It costs the business $1,000 to manufacture each patio set. Therefore, the total cost to produce the 10 sets is $10,000. The department store is willing to pay $1,200 per set on the order, for a total amount due of $12,000. However, the department store demands a net 30 term on the payment. Therefore, General Patio Furniture, Inc. must wait 30 days, plus the initial two week manufacturing period before payment will be received.
While General Patio Furniture, Inc. is waiting 30 days (plus the initial two week manufacturing period) to receive payment on the initial order of 10 patio sets, the company does not have adequate cash to purchase the materials needed to produce another incoming order of 20 patio sets from a separate department store. While waiting for the first invoice to be paid, General Patio Furniture, Inc. must place a hold on incoming orders – which will ultimately cause a delay in delivery of the finished products to the second department store and also any future customers.

When deliveries are late, customers become agitated and angry – and often choose to take their business elsewhere.

Factoring examplesIf General Patio Furniture, Inc. wanted immediate cash based on the outstanding invoice to the initial department store that offered to pay $1,200 per delivered patio set (for a total of $12,000 for 10 sets), the invoice can be sold to an invoice factoring company, in which case General Patio Furniture, Inc. would receive an immediate payment equal to approximately 85 percent (exact percentage varies by agreement) of the invoice total. Once the invoice is collected in full by the invoice factoring company, the additional 15 percent of the total amount due on the invoice will be provided to General Patio Furniture, Inc. minus a pre-agreed upon fee – – which is usually equal to a small percentage of the total value of the invoice(s).

For example, if the fee percentage is equal to 2 percent of the total invoice, the dollar value of the fee would be $240, and the amount General Patio Furniture, Inc. would receive in total for the sale of 10 sets to the original department store would be $11,760 – – which is still a significant profit.

The Many Benefits of Invoice Factoring
Invoice factoring is not right for all businesses that exist , but it is certainly a good option for a large percentage of them. Companies in the manufacturing, wholesaling, service, and government contracts industries are prime candidates that stand to benefit from factoring their accounts receivables. The ability to effectively utilize cash provided by an invoice factoring company to maintain operating expenses and meet payroll obligations provides a definite advantage to businesses that are competing against others in their industry. Making excellent financial decisions is the key to success for any business – and invoice factoring is quite possibly the best solution when a business is suffering from growing pains or cash flow issues.
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Editor’s Note: Greg Curtiss is President of The Invoice Bankers. Mr. Curtiss previously was a lawyer and has passed the CPA exam. He has been in business for over 25 years. You can reach him by calling 303-740-7600 or 1-888-740-1750.