Accounts Receivable Factoring

Danbury provides services for the financing of accounts receivable.

Program Highlights

  • Initial Credit facilities from $500,000 to $5,000,000; renewal extendible to $10,000,000
  • No financial covenants or field audits
  • Funding of invoices is largely dependent on the creditworthiness of the Client’s customers; not the financials of the Client
  • Advance rates up to 90% with no insurance requirements
  • Quick approval process; with a few business days of receipt of information from the Client
  • No required contract term or minimum funding limits

Danbury Because…

  • Danbury’s origins date back over 60 years
  • Through our outsourcing agreements we provide award-winning customer service and state-of-the art systems and reporting through a real time internet Client link
  • Depository relationship is maintained in a Canadian Bank domiciled in the Client’s Province of record

Client Benefits

  • Cash flow injection to fund growth, refinance existing debt, catch up on past due payables or other working capital needs
  • True ‘floating” credit limit to maximize availability and facilitate Client sales growth
  • Professional comprehensive A/R management services:
    • Credit reviews and credit limits for each of the Client’s customers
    • Collection assistance
    • Credit protection from bad debts
  • 24-hour online secure account access
  • Export Debtor Programs, for Clients who export beyond North America; often without the need for account debtor insurance

FACTORING

The term "factoring" refers to the outright purchase and sale of accounts receivable (A/R) invoices at a discount from their face value. The structure, terms and conditions of such a transaction may vary in any number of ways, as evidenced by the array of factoring programs currently available throughout the Country.

Companies engaged in the business of buying accounts receivable are called "factors." Factors often exhibit flexibility rarely demonstrated by banks and other secured lenders, whose activities are more generally restricted by regulation and prevailing law.

Companies selling their receivables are typically referred to as "clients”. The client’s customers, who actually owe the money represented by the invoices, are generally known as "account debtors". The cash which a factor issues to a client as initial payment for factored invoices is typically called an "advance."

Factoring differs from commercial lending because it involves a transfer of assets rather than a loan of money. In assessing risk, therefore, factors look primarily to the quality of the asset being purchased (i.e. the ability to collect borrower receivables), rather than to the underlying financial condition of the seller/client. This focus makes factoring a suitable vehicle for many growing businesses or businesses in turnaround when traditional commercial borrowing proves either impractical or unavailable.

Invoice Eligibility Criteria

In the factoring industry, the term "accounts receivable" normally refers to short-term commercial trade debt having a maturity of less than 90 or, at the outside, 120 days. Similarly, factors generally refuse to purchase "pre-ship" invoices that their clients sometimes generate prior to shipping goods or providing services to account debtors. Many factors will immediately terminate a factoring relationship if they discover that their clients are attempting to factor "pre-ship" invoices.

Factoring vs. Accounts Receivable (A/R) Lending

Although factoring is occasionally confused with A/R lending, it differs both legally and operationally. Legally, a factor takes immediate title to the invoices it purchases. The A/R lender, on the other hand, never takes title to invoices unless and until the borrower defaults on its loan agreement.

In connection with the transfer of title, the factor purchases the right to collect payments directly from account debtors, who thus become legally obligated to the factor. An A/R loan, however, does not legally obligate account debtors to pay the lender directly, except when the lender notifies them of a default by the borrower.

Operationally, the factor differs from the A/R lender because the factor concentrates on the aging, collection, and posting of each factored invoice. By contrast, the A/R lender does not track the payment status of every individual invoice generated by the borrower in the normal course of business. Further, while an A/R lender will have virtually no interaction with individual account debtors, the typical factor will find it necessary to contact them directly as a matter of course.

The Mechanics Behind a Typical Factoring Transaction

Factoring occurs in a variety of forms, but the most typical is described below.

Advance/Reserve

This type of factoring is by far the most widely practiced. Upon taking title to invoices, the factor immediately pays to the client a percentage of their total face value. This payment (called the "advance") typically falls between 70% and 85%, but may go as high as 90% (medical invoices; insured invoices, etc.). After successful collection of payment from the account debtors, the factor subsequently remits the balance of the invoice amount(s) (usually called "the reserve") to the client, minus the factor's earned fees. The reserve provides the factor with available funds from which to draw its fees, and furnishes a buffer against defaults by clients and/or account debtors.

Advance/reserve factors generally structure their fees as an initial discount rate (typically ranging between 1.5% and 3% of invoice face value), followed by subsequent increases scheduled over the length of the actual collection period. The collection period begins on the day that the factor advances funds to the client (which is not always the same as the invoice date).

Why Businesses Factor

Businesses most frequently factor in order to finance sales growth. Additionally, many companies turn to factoring as bridge to future debt or equity financing. Factoring is still widely misunderstood by many business people, who continue to view it as a tool of last resort for companies with terminal financial problems. In reality, however, the opposite is true. Companies on an inexorable downhill slide make poor factoring candidates because they present a level of risk that most factors strive to avoid. Factoring is therefore best seen as a dynamic financial tool that enables growing companies to accelerate and stabilize cash flow. As an alternative to bank financing or venture capital, factoring can address a wide range of business situations. The most common reasons why business turn to factoring appear below:


Availability

In Canada, during the past five years, factoring has become more readily available to small and medium-sized businesses than traditional bank lending.

To obtain bank financing today, companies generally need to:

  1. Produce financial statements demonstrating a minimum of three to five years of profitable operating experience;
  2. Possess a strong collateral base including equipment, real estate and other hard assets; and
  3. Maintain a debt/equity ratio of approximately 2:1 or better, depending on the industry. Although banks expect to see a strong receivables portfolio, they generally will not be comfortable relying on receivables as the only available collateral.

Many growing enterprises fail to meet bank lending criteria for one reason or another. For example, bank financing often remains unavailable to service companies with no real assets other than receivables, and to younger companies with short operating histories.

By contrast, a commercial business becomes a reasonable factoring prospect as long as it can demonstrate the following:

  1. That it has an unencumbered portfolio of collectable accounts receivables which are payable by credit-worthy account debtors without dispute or offset;
  2. That it has the margins necessary to absorb the factoring discounts;
  3. That factoring will, in fact, improve the company's cash position and enable it to accommodate increased sales.

Very few factors require prospective borrowers to submit audited financial statements and most do not even impose any minimum net worth requirements.

Flexibility

As a rule, factoring executives exercise a greater degree of decision-making autonomy than banking executives. This autonomy generally allows factors to respond rapidly to business opportunities and borrower needs. While a bank might take months to process and approve a commercial loan application of any size; factors routinely execute sizable transactions within ten days (or less) of an initial prospect meeting. Moreover, factoring relationships tend to be more open-ended. A borrower seeking to increase a bank credit line, for example, will inevitably have to submit new documentation and financial statements for subsequent review by a lending committee. Factors, on the other hand, frequently operate without formal ceilings, and often issue immediate approval for larger-than-normal advances based solely on the performance of the borrower's current portfolio and the quality of submitted receivables. Lastly, to accommodate good borrowers in emergency situations, factors may be more likely than banks to modify normal operating procedures.

Balance Sheet Considerations and Equity Preservation
Because it represents the sale of an asset, factoring enables companies to obtain working capital without taking on new debt or giving up equity.

Collateral Preservation

As a condition of issuing a loan, commercial lenders typically secure their position by taking all of a borrower's business assets as collateral. Even if the collateral value greatly exceeds the potential loss exposure, lenders rarely display any flexibility on this issue. Factors, on the other hand, usually limit their collateral to borrower accounts receivable, leaving other assets unencumbered.

Refinancing and Bridge Financing

Factoring provides a practical transitional tool for restructuring long-term financial arrangements. It is therefore particularly useful for companies seeking to extricate themselves from unfavorable or overly restrictive bank relationships. Numerous young businesses rely on factoring to help them reach the point where they become viable candidates for less expensive bank financing or equity funding. Lastly, factoring sometimes plays a role in acquisition financing by supplying the necessary "gap" funding to make the acquisition workable.

Value-added Services

A factor's value to its clients frequently goes beyond advancing funds. Most factors typically provide such critical A/R support services as customer credit analysis and approval, invoice handling, collection, posting, accounting and reporting. For many businesses, even those with access to long-term commercial credit, the desire to obtain these services actually drives the decision to factor. It is not unusual, therefore, to find instances where a borrower regularly factors all of its receivables but only rarely draws advances from the factor.