Cash Flow Revolution: How Factoring Working Capital Changes Everything
Stan Prokop
Canadian Business Financing | Cash Flow Financing | Asset Based Lending | Equipment Finance | Lender Financing | Purchase Order Financing | Acquisition Financing | SAAS Financing | Acquisition Financing
Breaking the Cash Crunch: Factoring Working Capital
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YOUR COMPANY IS LOOKING FOR WORKING CAPITAL!
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Factoring Working Capital: Financing in Canada
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Working Capital Financing In Canada.
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When business owners and financial managers consider ‘cash flow , ‘ two terms are almost synonymous: factoring and working capital. Is there a difference?
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Yes, there is a significant difference. Accounts receivable factoring is a specialized financial service that helps businesses improve their cash flow by facilitating funding for various industries, such as manufacturing and telecommunications.
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WHAT IS FACTORING?
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Factoring is a financial transaction where a business sells its accounts receivable to a third-party company, known as a factoring company, at a discount.
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This process allows businesses to receive immediate cash for their outstanding invoices rather than waiting for customers to pay. Factoring, also known as accounts receivable financing or invoice factoring, is a popular financing option for businesses looking to improve their cash flow, reduce debt, and increase working capital.
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By converting invoices into immediate funds, businesses can maintain smooth operations and invest in growth opportunities without the delays associated with traditional payment cycles.
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?PERMANENT WORKING CAPITAL VERSUS SHORT-TERM FINANCING FOR DAILY OPERATIONS
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We believe that when Canadian businesses think in terms of working capital that is often in the context of permanent working capital.
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This can take several forms: a term loan, a mezzanine loan, or subordinate debt. These are the key terms of 'high finance ' for working capital loans!
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With such loans, businesses typically use the working capital derived from the loan to invest in sales and marketing, implement new products and strategies, and purchase inventory and materials for further corporate growth.
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THE WORKING CAPITAL LOANS OPTIONS
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There are numerous advantages to a working capital term loan. The loan's repayment is typically in the 5 -7 year range, which clearly frees up cash flow.
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Let’s do a quick example -
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If a Canadian business borrowed $150,000.00 and was successful in getting a term loan in place, the monthly payments over a 5-year period would be approximately $3000.00 per month. (We used an interest rate of 8% just as an example.)
Depending on the lender's flexibility, payments can be structured or even potentially deferred based on the customer’s needs and overall financial situation.
Factoring providers offer a percentage of the invoice value as a cash advance, usually processed within 24 hours.
Naturally, any financing scenario as positioned above is long-term permanent working capital, which is generally viewed positively by business owners and their lenders. It is, in effect, a form of ‘patient working capital ‘.
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WORKING CAPITAL LOANS SUPPLEMENT YOUR OTHER SECURED CREDITOR RELATIONSHIPS
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Long-term working capital loans 'complement 'your existing secured creditor relationships. For the purposes of this article, we won't dwell too much on the aforementioned subordinated debt and mezzanine debt—we will simply say they are unsecured ' cash flow ' loans, long-term in nature, with rates substantially higher than chartered bank rates due to the general unsecured nature of the loans.
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The lender is simply taking a position that your firm will be able, based on historical and present financials, to repay the loan out of cash flows.
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ENTER THE ' FACTORING ' SOLUTION!
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We've discussed the 'permanent ' working capital loan and seen its characteristics, i.e., term loans, longer repayment schedules, fixed rates, terms, and structures. Now, let’s look at totally immediate working capital/ cash flow, which many customers in Canada are achieving by using a factoring or working capital cash flow facility.
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ACCESSING FUNDING IMMEDIATELY!
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The invoice factoring solution is immediate. Transactions and facilities can usually be approved in a much shorter timeframe. Every customer is different, of course, and in many other industries, but based on a review of your financials and your overall business model, customers receive immediate significant advances (typically 90%) of their invoices.
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IT'S ALL ABOUT YOUR ACCOUNTS RECEIVABLE
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Since the heart of any business cash inflow comes from collected receivables businesses who 'struggle' with the collection process often face cash flow shortages due to slow-paying customers.
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Conversely, as receivables and inventory build up for good reasons (good reasons = more sales), the company's investment in them grows.
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KEY ELEMENTS OF FACTORING AGREEMENTS
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Factoring, or receivable discounting, is based on the overall size, quality, and collection experience related to your billings.
It is safe to say that current invoices are more easily factored (sold) than 65-day unpaid invoices from slower-paying customers. However, any billed sales under 90 days old are generally financeable under this method.
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Factoring receivables refers to the financial practice of selling existing invoices to a third-party company for immediate cash.
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TYPES OF FACTORING
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There are several types of factoring, each catering to different business needs:
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QUALIFICATION REQUIREMENTS
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To qualify for factoring, businesses typically need to meet certain criteria:
Factoring companies also consider other factors, such as the industry and the creditworthiness of the business’s customers.
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These requirements ensure that the factoring company can effectively manage the risk and provide the necessary cash flow support.
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PRICING AND FEES
The pricing and fees for factoring vary depending on the factoring company and the type of factoring chosen.
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Typically, factoring companies charge a fee ranging from 1-5% of the invoice value. Additional fees miscellaneous may also apply.
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The factoring fee is usually determined by the monthly volume of receivables and the creditworthiness of the business’s customers.
For instance, businesses with a high volume of receivables or customers with lower credit scores may face higher fees. Understanding these costs helps businesses plan their finances and choose the most cost-effective factoring solution.
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APPLICATION PROCESS
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The application process for factoring is straightforward and efficient. It typically involves providing financial statements and other documentation to the factoring company. The company will review the application to determine if the business qualifies for factoring.
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Once approved, the factoring company provides a contract outlining the terms and conditions of the sale. The business then submits a batch of invoices to the factoring company, which purchases them at a discount.
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The factoring company collects payment from the customers and pays the business the invoice balance, minus the factoring fee. This entire process usually takes a few days to a week, depending on the transaction's complexity and the parties' responsiveness.
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By understanding the application process, businesses can better prepare and expedite their access to much-needed working capital.
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HOW DOES TRADITIONAL FACTORING WORK
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Many factoring company firms assume the role of your collection department. Some business owners actually welcome this as they have utilized the very popular concept of 'outsourcing' for their collections. Previously unheard of years ago, outsourcing is now a way of doing business.
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So is factoring in all goodness. Certainly not, what type of financing is. In factoring, there is a higher cost to finance your A/R portfolio.
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In Canada, there are tens and hundreds of nuances and administrative procedures around the factoring process that many business owners struggle with. Factoring should be used for growth, not survival, and other strategies can be explored at a lesser cost and less intrusiveness to your business.
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THE BEST FACTORING SOLUTION - SPOILER ALERT - IT'S ' CONFIDENTIAL'
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Oh, and if you’re looking for the ultimate A/R finance solution , you should consider our recommendation of? Confidential A/R finance . This allows you to bill and collect your receivables without any other paperwork intrusion.
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The application process in all factoring services makes it easy to get started and approvals are typically very fast.
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KEY TAKEAWAYS
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CONCLUSION
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In summary, small business owners considering the ' working capital/cash flow ' problem can consider long-term loans or short-term receivables financing strategies for growth.
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There are several options for financing both of those. Other options (for example, a sale/leaseback of your assets or a real operating margined facility with a Canadian chartered bank) should also be potentially explored.
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Review all options - Call? 7 Park Avenue Financial, a trusted, credible, experienced Canadian business financing advisor with a track record of success.
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FAQ
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How does factoring in working capital improve my business's cash flow?
Factoring working capital converts unpaid invoices into immediate cash, eliminating long wait times for customer payments and providing steady liquidity for your business operations.
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Can factoring in working capital help me take on larger projects or clients?
Yes, by providing quick access to funds tied up in invoices, factoring working capital allows you to take on more significant projects or clients without worrying about the strain on your cash flow.
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Will factoring in working capital affect my customer relationships?
Factoring can enhance customer relationships by allowing you to offer more competitive payment terms without compromising your financial stability.
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Is factoring in working capital a form of debt?
No, factoring is not a loan. It's a sale of your accounts receivable, which means you're not incurring debt or interest charges.
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How quickly can I access funds through factoring in working capital?
With factoring, you can typically receive funds within 24-48 hours of submitting an invoice, providing rapid access to working capital .
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What types of businesses can benefit from factoring in working capital?
Factoring working capital can benefit many businesses, particularly those in B2B industries with longer payment cycles, such as manufacturing, wholesale, and professional services.
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Are there any upfront costs associated with factoring in working capital?
While fee structures vary, most factoring companies charge a percentage of the invoice value rather than upfront costs, making it accessible for businesses of all sizes.
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How does the factoring company determine which invoices to accept?
Factoring companies typically assess the creditworthiness of your customers rather than your own business, focusing on the likelihood of invoice payment.
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Can I choose which invoices to factor, or do I need to factor all of them?
Many factoring companies offer flexible arrangements, allowing you to select which invoices to factor in based on your cash flow needs.
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What happens if my customer doesn't pay the factored invoice?
This depends on the type of factoring agreement. You may be responsible for buying back unpaid invoices in recourse factoring, while non-recourse factoring shifts this risk to the factoring company.
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What's the difference between factoring and a traditional bank loan?
Factoring working capital provides immediate funds based on your accounts receivable without creating debt. Bank loans involve borrowing money that must be repaid with interest, regardless of your current sales or cash flow situation.
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How does factoring in working capital impact my business's balance sheet?
Factoring working capital typically involves selling assets (accounts receivable) rather than liabilities, potentially improving your debt-to-equity ratio and making your business more attractive to other lenders or investors.
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Can factoring in working capital help my business during seasonal fluctuations?
Yes, factoring working capital is particularly useful during seasonal peaks. It allows you to quickly access funds from increased sales without waiting for payments, helping to smooth out cash flow during slower periods.
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' Canadian Business Financing With The Intelligent Use Of Experience '
?STAN PROKOP 7 Park Avenue Financial/Copyright/2024
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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