Using Receivables To Increase Profits
By Craig McGrain, President Durham Funding
When business owners look into financing for capital projects or expansion, most turn to banks. In today’s economy, however, the tight credit restrictions are causing many to look for alternative funding. If a business is growing and profitable, it is possible to obtain the required funding without increasing debt.
A process called factoring allows businesses to transfer their accounts receivable into cash. Factoring firms like ours have money to lend without burdensome restrictions imposed by traditional funding sources and their regulators. All of our capital is private and unregulated.
Factoring is not a new concept. Rather, it is one of the oldest forms of financing, dating back to biblical times. It comes from the Latin word for “he who gets things done.” Certain people in the business community have the misconception that factoring is for troubled companies. That is not the case. Healthy, profitable companies use factoring. The factoring transaction simply converts one asset (the receivable) into another asset (cash). Therefore, financial ratios and preexisting debt covenants are unaffected.
Here’s how factoring works: A factoring firm purchases its client’s accounts receivable (invoices) at a discount in exchange for immediate cash, and title to the accounts passes to the factoring company upon transfer of the cash. An average transaction can be completed by a Factor within a week of receiving its client’s financial information. Invoices are funded on the same day that invoices are received from ongoing clients. Clients typically pay a flat fee of 3% to 4% of the face value of the receivable.
Factoring generally increases a company’s actual cash profit as well as its net profit margin. Table 1 analyzes the impact of factoring on a hypothetical company’s profits. It demonstrates how the company makes more money factoring.
A real company – New Beginnings, Inc. – was two years old when it entered into its first factoring contract with Durham Funding. The company, which provides care for patients who have suffered traumatic brain injury, was the only company in the area with the people, government permits, licenses and approvals to handle larger projects. Owner Tanya Currier had spent years and large sums of money obtaining multiple contracts and training people. However, now she had to meet payroll and other expenses during the time between billing and collection. Factoring allowed New Beginnings to expand rapidly and become profitable. Within 18 months of the initial financing, New Beginnings was so profitable that it was self funding all new projects. Within 21 months, the company no longer needed to factor its receivables for basic cash flow, and paid off its credit line with Durham in full.
The Factor generally acts as its clients’ credit and collections department. The Factor analyzes the risk of providing credit to each of its clients’ customers and can tell their client in advance whether a potential new customer is credit worthy or should only be sold on a cash basis.
The factoring firm also becomes the main point of contact for collections. Before invoices are purchased, most account debtors (the party that is responsible for payment of the invoices) sign a confirmation letter stating that the goods or services have been provided and are in proper order, they will pay within term without condition and waive any right to offsets. This provides the factoring firm with confirmation that the receivable is properly issued and the ability to collect all sums without offset.
There are many factoring companies in the marketplace. They fit into two general categories. One is a small group of long established factors (CIT, Capital Factors, GMAC, Rosenthal). They service larger clients that traditional banks avoid, but have strict underwriting policies similar to traditional banks. The second category is a large group of smaller factoring firms with limited legal and risk management experience. This hampers their ability to effectively structure transactions.
Durham Funding does not fit into either of these categories. Durham can handle complex deals by structuring novel intercreditor agreements that protect its interests while allowing clients to satisfy the requirements of its creditors. Durham is extremely flexible and not limited by strict underwriting policies. A very extensive network of business partners, built over the last 15 years, includes brokers, bankers, accountants, lawyers and other professionals who generate deal flow, and broaden the deal size range from $25,000 to an unlimited amount.
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Attorney Craig McGrain is president of Durham Funding, a Factor located in Pittsford, NY.
