The Broker s Guide. to Factoring

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1 The Broker s Guide to Factoring

2 Copyright 2012 Datamax Marketing Systems, Inc. All Rights Reserved This book or parts thereof may not be reproduced in any form without permission from the publisher; exceptions are made for brief excerpts used in published reviews. Published by Datamax Marketing Systems, Inc Metro Parkway Suite 22 Ft. Myers, Florida, Printed in the United States of America This publication is designed to provide accurate and authoritative information with regard to the subject matter. It is sold with the understanding that the publisher is not engaged in the business of offering investment, tax, or legal advice. If such advice is required, the services of a competent tax, securities, or legal professional should be sought. This book is available at quantity discount pricing for bulk purchases. For information contact (239)

3 CHAPTER ONE Introduction to Factoring Factoring Defined Factoring vs. Lending Accounts Receivable Defined Terms of Payment and Cash Flow Case Studies The Factoring Industry A Brief History of Factoring Locating Today's Factors CONTENTS CHAPTER TWO Factoring Types, Structures and Conditions Factoring Terminology Types of Factoring Transactions Maturity Factoring Advance Factoring Discounts and Fee Structures Conditions of Recourse and Non-Recourse Notification and Non-Notification CHAPTER THREE Client Setup, Underwriting, and Advance Underwriting & Contracting The Verification Process Creating the Advance Schedule Debtors and Debtor Concentration The Factor's Reserve Collections and Reserve Distributions Client and Customer Reports CHAPTER FOUR Good Client Characteristics What is a Desirable Client? Navigating "Deal Breakers" Specialized Transactional Areas

4 CONTENTS CHAPTER FIVE Additional Product Areas for Brokering Additional financing Tools Asset-Based Lending Inventory Finance Purchase Order Finance Letters of Credit Forfaiting Transactions Equipment Leasing CHAPTER SIX Industry Opportunities in Business Development What is a "Factoring Broker"? Industry Requirements The Business Development Officer's Role The Independent Broker's Role Your Office and Equipment Selecting Your Business Name Types of Industry Brokers Your Personal Assets and Goals Commissions and Earnings Potential Brokered Transaction Deal Flow Completing Company Profiles The Uniform Commercial Code CHAPTER SEVEN Marketing and Prospecting Direct Marketing / Delivery Systems Recognizing Factoring Prospects Building Marketing Lists Database Managers Offers Direct Mail Marketing Classified Advertising Prospecting Types of Prospects Prospecting Campaigns Telephone Marketing Seminars and Workshops Networking Volunteering Final Recommendations

5 CHAPTER EIGHT Continuing Education The IACFB The Forum Special Membership Examination CONTENTS 5

6 6

7 Preface PREFACE The career you are exploring, that of factoring consultant, is one that offers well prepared entrepreneurs a unique opportunity to earn an exceptional income while also enjoying a high degree of prestige and vocational respectability. As a Commercial Finance Consultant in the factoring and alternative commercial finance industries, you will be performing a valuable financial service to small and mid-size business owners while taking pleasure in a profession that is both personally and financially rewarding. Lifestyles in the world continue to change rapidly. In Europe, socialism is collapsing at an ever increasing rate with Spain and Italy now beginning to live the Greek experience. In America, the promised recovery by the Obama administration has shown to be primarily Hope and absent Change. Banks continue to focus on balance sheet repair rather than lending to America s entrepreneurs. It is very unlikely that these circumstances will change in the near future. For many Americans today, a change in career is not a choice but a necessity. Corporate downsizing and the relocation of high paying jobs to distant offshore locations is now commonplace. With true double-digit unemployment the norm, job opportunities offering income levels which can actually support an average family are becoming more and more scarce. The solution to many faced with continued job loss and salary reductions, is to exit the world of the dependent employee and develop their own entrepreneurial business. This publication, The Broker s Guide to Factoring, is designed to introduce you to a fascinating industry full of opportunity and challenge. With additional support available through the IACFB (International Association of Commercial Finance Brokers), it will greatly shorten the length of time required for you to physically learn the basics of brokering in the factoring industry, know the industry's growing importance as a financing method of choice for small and mid-size business owners, and to then assist you in generating your first clients and commission income as an industry Commercial Finance Consultant. The working knowledge of the product areas introduced in this text will provide you with opportunity and the... flexibility to live and work wherever you want possibility of achieving a high standard of living freedom to achieve true financial independence. A career in commercial finance consulting represents an exceptional opportunity for those able to meet the challenge. We recognize, however, it is not for everyone, but rather for the select few with the drive and determination to break away from the pack and lift themselves well above the crowd. 7

8 This guide is designed to be used in conjunction with and to supplement the continuing education products available through the IACFB. For additional information, visit: 8

9 CHAPTER ONE Introduction to Factoring 9

10 receivable discount rate advance schedule report factoring fees brokers F actoring is one of the oldest charge back forms of commercial verification finance known to man. Though well understood by finance professionals, notification assignment collection report accounts receivable due quickly find that your new purchase many business owners are not aware of its power as a powerful entrepreneurial business financing medium. Consultants in the factoring industry perform the job of "educator" to small and midsize business owners. If equipped with the proper tools for success, you will career will command respect and admiration from virtually everyone you meet. application factoring fees brokers invoice recourse due diligence charge back commission marketing 10

11 Factoring Defined About Factoring Factoring is a well practiced method of business finance where invoices (short-term trade debt) are sold to a finance company (the factor) for immediate payment to the seller of those invoices. Such factored invoices are purchased at a small discount to their face value. Factoring is used to speed up cash flow when invoices aren't paid immediately by customers who have been granted 15, 30, 45 day terms of payment or longer. While certainly not a household word, factoring in the United States is an enormous industry with current sales volume of approximately $150 billion annually. For many startup and first stage businesses having little access to traditional bank financing, factoring has no equal in its capacity to free up working capital for growth and business expansion. As it is traditionally recognized, factoring is never a loan. It always involves the actual purchase of the accounts receivable of a business at a discount to their face value. When first introduced to its characteristics as a proven form of business finance, it is important to make immediate note as to the major differences between factoring and the more commonplace methods of commercial finance such as business term loans and asset-based lending. As it is traditionally recognized, factoring is never a loan. It always involves the actual purchase of the accounts receivable of a business at a small discount to their face value. Contrarily, asset-based lines of credit are always structured as a loan and though many modern day factors have developed some rather exotic hybrid fee and purchase structures for their financing models, the financial basis for these transactions is always that of purchase and sale rather than loan and repayment. With the basis for such financing predicated entirely upon the accounts receivable of a business as collateral, factors differ markedly from banks and other traditional lenders that will provide business loans based on more typical collaterals such as real estate, equipment, inventory, and buildings or other structures. In essence, factors simply buy "paper"... invoiced short-term obligations owed by one business to another. Because of their actual ownership of the purchased accounts receivable, factors will become very involved in the day -to-day operations of their client's business and perform most functions of collection and accounting. They will be in periodic contact with customers ( known as account debtors) to make certain timely payment is made upon the purchased invoices and, in most cases, will insure that payments upon the invoices will be mailed to the business address (or lockbox) of the factor rather than to the address of the factor's client. 11

12 Factoring Defined Factoring...A Working Definition As you will learn, factoring is basically a specialized form of commercial finance for businesses, but it has many complex variations and styles. While you will normally see factoring defined in the traditional sense as on the previous page, it is important for broker s to develop a working definition" or one that will be used to explain factoring s many benefits to a business owner and prospective client. Factoring is nothing more than a method of commercial finance that relates to the accounts receivable of a business. Factoring is not a working capital loan to be used at the business owner s whim. Factoring simply does one of two things: Because factoring involves the sale of invoices waiting to be paid, its availability as a financing alternative is naturally only offered to those businesses that invoice for their sales. Businesses that operate in retail (over the counter sales for cash or credit card) collect immediately for goods sold or services rendered and have no need for a factor s services. a) factoring allows businesses that are currently operating on a cash basis with their customers to offer terms of payment (30, 45, 60 days) for goods delivered or services performed. In virtually all cases when terms of payment are offered, customers tend to buy more. Therefore, factoring is a form of commercial finance which finances terms of payment and allows the customers of a business to buy more on credit. b) factoring allows businesses that are currently offering terms of payment to their customers and subsequently may have tens of thousands or even hundreds of thousands of dollars of working capital trapped in accounts receivable, to free up those funds by selling the accounts to a factor for immediate cash. Once sold, the business can use the freed-up capital for any number of reasons such as purchasing inventory, paying vendor obligations, purchasing new equipment, investments, etc. Therefore, factoring is also a form or commercial finance which liquidates accounts receivable and allows the business owners to access their working capital. Business to Business Transactions Only Because factoring involves the sale of invoices (accounts) waiting to be paid, its availability as a financing alternative is naturally only to those businesses that invoice for their sales. Businesses that operate in retail (over the counter sales for cash or credit card) and collect immediately for goods sold or services rendered have no need for a traditional factor s services. 12

13 Factoring vs. Lending Factoring vs. Lending In understanding factoring and why it may offer certain advantages over other forms of commercial finance in specific applications, it is important to bear in mind several facts. First, as previously mentioned, true factoring is never a loan. It involves the actual purchase of a company s accounts receivable. Second, because of this purchasing relationship, factors will focus primarily on the creditworthiness of the account debtors (customers) of their client when purchasing invoices rather than the client s credit (or lack thereof). That is not to say that factors do not look at the financial health of their clients. Account debtor credit is simply more important. Factoring vs. Lending One of the primary advantages of factoring over the more typical business loans offered by banks and other traditional lenders is the flexibility offered by the factoring transaction and the ease and simplicity with which a factoring arrangement can be put in place. In most cases, the underwriting of a new factoring client can occur within hours, not weeks as is the case with loans from banks. Factoring clients do not have to wait for loan committee approvals or lengthy credit checks. In reality, factors will spend much more time examining the credit of the client s major customers than that of the business client itself. Due to this flexibility, factoring provides a ready capital source to many businesses that lack an adequate credit history to make themselves attractive to banks and other lenders. Many service companies in their early stages of operation, for example, must frequently ignore attractive sales opportunities due to inadequate capitalization and cash flow constraints. Banks cannot provide such capital due to their very rigid internal credit policies and external regulatory limitations. Even in those rare instances where banks can provide small commercial loans, such credit lines are generally much too small to satisfactorily support the significant opportunities that are present for sales growth. Without question, factors better meet the needs of early stage, rapid growth entrepreneurs that exhibit an ever increasing need for additional working capital. Because factors actually purchase the accounts receivable of a business and oversee their collection, they can accommodate the needs of smaller companies in these earliest stages of growth. Such companies are much too weak financially to qualify for typically bank lending relationships but due to the factor s ability to monitor and re-direct payments upon the invoices to its own offices or lockbox facility, such financial extensions of credit are easily put in place for even the youngest of businesses with little or no credit history. 13

14 Accounts Receivable Defined The most common "garden variety" account is the normal unsecured account generated from the day-to-day sales of goods or services by one business to another under some terms of payment. Accounts Receivable Defined As a commercial financing mechanism, factoring is really nothing more than a method of financing the accounts receivable of a business. What are accounts receivable and why would you want to finance them? In laymen s terms, accounts receivable are simply invoices for work performed or for goods delivered to a customer. Because the customer did not pay cash (C.O.D.) at the time that the service was performed or the goods delivered, an invoice or bill must be sent to the customer documenting the service / goods, the amount due, and the terms of payment (when the bill must be paid). Granting terms of payment will help attract customers that feel they can turn the goods and receive payment from buyers before their supplier s bill is due and the check sent. Types of Accounts (Invoices) Factoring and asset-based lending are forms of accounts (invoice) finance and therefore depend on the eventual payment by the client's customer on invoices. While this may seem straight forward, there can occasionally be problems in obtaining payment upon certain types of accounts generated by a business. The most common garden variety account is the normal unsecured account generated from the day-to-day sales of goods or services by one business to another under some terms of payment. Such accounts are simply commercial paper. A service has been performed or goods delivered by one business to another and payment is due at some not-to-distant time in the future. Some accounts may actually be secured by the goods sold (thus making them chattel paper) such as in the case of a new automobile temporarily financed (floor planned) by the vehicle manufacturer when sold to a dealer. Other accounts may be secured by a letter of credit or even by statutory liens such as mechanic's liens (construction) or warehouseman s liens. In some cases, accounts may have non-standard terms or conditions of sale where goods are not truly sold. Such accounts, called consignment accounts (right to return unsold goods), allow the customer to attempt to sell the goods on a best efforts basis and then return the balance. Contra transactions result when two businesses each sell or provide services to each other and subsequently offset the invoices. Due to this possibility of offset, such accounts are typically not eligible for factoring or lending of any kind 14

15 Terms of Payment What Are Terms of Payment? As you will learn as you continue to study this guide, most factoring transactions, as well as many asset-based lending transactions, are created simply to provide a readily accessible method of financing a company s terms of payment policy and to remedy the cash-flow problem caused by granting those attractive credit terms to customers. At some point in time, as companies grow, they are almost required to initiate a terms of payment policy. Terms of payment are granted by businesses as an accommodation for a singular purpose that is to attract more business from large (and sometimes not so large) creditworthy customers. Many creditworthy customers, on the other hand, demand terms of payment for a singular purpose..that is to benefit from the payment delay provided under the terms of payment policy and to allow time to sell products or provide services and generate enough additional cash to subsequently pay the vendor s invoice. For large corporations, the benefits of demanding extended terms of payment from vendors are very significant. When one business grants terms of payment to another, it is in effect, creating a short-term business loan or commercial paper. Large corporations can dramatically change their cash-on-hand balances by demanding longer terms of payment or by simply increasing the length of time before they actually pay their bills. Take for example, a large national retailer that has current accounts payable of $50,000,000 and routinely pays its invoices in 30 days. By simply increasing its terms of payment from 30 to 45 days, it will wait an additional 15 days prior to making payment resulting in an interest free loan of $25,000,000 at the expense of its vendors. Large corporations can dramatically change their cash-on-hand balances by demanding longer terms of payment or by simply increasing the length of time before they actually pay their bills. Because of the attractiveness of such non-interest bearing loans (delayed payments) to large companies, it is not unusual to see contracts and large orders granted to those vendors that offer the most attractive terms of payment, even if the prices for goods or services are slightly higher than from competitors. For most businesses (or at least those that have some capability of operating at a profit), increasing the extension of credit to customers by granting extended terms of payment is the primary reason for problems of cash flow and for periodic working capital shortages. And as you will soon learn, the most popular method of commercial finance world-wide that directly addresses the problems caused by extending terms of payment is commercial accounts receivable factoring. 15

16 Cash Flow Understanding Cash Flow Before you can truly understand the importance of factoring as a financing method for small and mid-size business owners, you must have a keen awareness of the many problems that factoring can provide beneficial solutions to and why this unique method of alternative commercial finance is so powerful. Foremost in understanding commercial factoring, you must first have a working knowledge of the term cash flow. Have you ever heard a business owner comment, I think my company is doing but I'm always short of cash to pay my bills. Everyone says I m doing fine but if that s so, where s all the money? The problem so described is a very common one. It is simply a problem of cash flow. Regardless of which one of these categories may be actually creating a company's cash flow problems, factoring can often provide the solution. Defining cash flow can be difficult and while it may seem straight forward to some, it can be hard to explain. Many people use the term daily although they are not completely sure of its true definition. Taken literally, cash flow refers to any transaction that, in the normal course of business, will result in a change in the cash account of that business. In other words, at the end of the day, did cash come into the business or did cash go out. Though the activities that cause cash inflows or cash outflows may be varied, they can usually be divided into two general categories: those that are associated with normal daily business operations such as purchasing, production, sales, and collections, or; those that are the result of other non-operational activities such as creating or repaying a loan, an owner s investment or reduction of investment, or the purchase or sale of various assets. Regardless of which one of these categories may be actually creating a company s cash flow problems, factoring can often provide the solution. Factoring, and the various other forms of accounts receivable finance, directly address one of the most prominent causes of reduction in cash flow, that being the length of time necessary to collect on a company's accounts receivable from sales and the growth in volume of such accounts receivable as a result of increased sales activity on a month-tomonth basis. 16

17 Cash Flow A general understanding of cash inflows and cash outflows can be realized by looking at an individual transaction. For example, a manufacturer that sells $100,000 of shovels to a large retailer with 60 day terms of payment. A very simple transaction is below. SALES...the proceeds from the sale of shovels to a retailer Sales $100,000 COGS...(cost of goods sold) the cost to actually produce the shovels including worker s wages and raw materials Raw materials $25,000 Labor $25,000 Total $50,000 GROSS PROFIT...(Sales minus COGS) $50,000 At first glance, it would appear that no cash problem could exist in this example. The manufacturer has earned a healthy $50,000 profit on the sale. It is the terms of payment granted to the retailer, however, that creates the cash flow problem. If the shovels delivered required two weeks to manufacture, it is evident that the business owner must make a payroll of $25,000 every two weeks until the actual payment of $100,000 is received from the customer. This will result in four payroll periods or a total of $100,000. In addition to the payroll obligation, the manufacturer must replace $25,000 in raw materials inventory for a grand total of $125,000. Immediate cash sales (C.O.D.) could solve this problem. Without cash sales or sales with shorter terms of payment, however, this business will soon run out of capital and may be forced to lay off valuable employees due to its inability to make weekly payroll. What becomes immediately clear is that the solution to this problem is to somehow reduce the length of time it takes to collect the payment for the sale and to book the profit. One way to do so is to not grant the terms of payment in the first place. However, in most cases, it is likely that the terms of payment were not granted". With major retailers, terms of payment are a condition of sale and assumed. The true solution to the problem, without losing the sale, is to employ the services of a factor who will purchase the accounts for immediate cash as they are created. That cash can then be employed to meet the weekly payroll and other payables obligations of the company. 17

18 Case Study Case Study / John's Security Guard Service, Inc. John provides 24 hour security guard service to gated communities. He has slowly built his company up over 5 years and enjoys an excellent reputation for service. The property management companies responsible for payments to John's for its services are notoriously slow payers and the further growth of John's Guard Service has been severely limited due to weekly payroll constraints. John has attempted to secure financing for his company at a local community bank but has been turned down on two separate occasions due to a slightly tarnished credit history and lack of any meaningful "hard asset" collateral. Because of its excellent reputation, John's Guard Service has been offered a contract to provide security guards to 37 gated communities in his local area that, if accepted, would triple the size of his company overnight. Unfortunately, the large management company offering the business to John also has a reputation for 75 day payment for services. John calculates the number of guards needed to cover all entrances at the 37 properties to be 65 and the communities require 24 hour guard protection for a total of 195 guards. With a weekly salary of $480 per guard based on a 7 day work week, John's weekly payroll requirement for the new contract will be $78,000. This means that because of the management company's 75 day payment history, John will have to bankroll his company for 11 weeks at $78,000 per week or a total of $858,000 to accept the new contract. John has only $37,000 in his business account and feels he obviously must decline the new business. John, however, remembered that he recently received a brochure through the mail that explained the benefits of something called factoring and its powerful financing capabilities. He contacted the broker that mailed it to him and explained the hopelessness of the new offer. The broker explained to John that factoring will provide him with the capabilities to say "yes" to the new contract and the broker immediately arranged a conference call with a factor's BDO (Business Development Officer). John was quickly provided with a factoring arrangement to purchase accounts at a discount rate of 3% for every 30 days. This means that John's fee rate will be approximately 7.5% on his invoices but with nearly a 30% profit margin, it will still allow him to record a gross profit of nearly $15,000 per week or over $750,000 per year from the new contract...a contract he was about to turn down. The growth of John's business is now assured. 18

19 Case Study Case Study / Betty's Building Maintenance Service, Inc. Betty's Building Maintenance Service, Inc. provides exterior building maintenance including pressure washing and window cleaning. As a minority (woman-owned) business enterprise, she receives many opportunities to compete for local city and county contracts but has declined these opportunities in the past due to the fact that the contracts are relatively large and both the county and city require 45 days to make payment (terms of payment) for services performed. Due to the fact that Betty's company has few assets to be used as collateral, she had been unable to secure any form of loan from local banks. Betty was contacted by Bill, a factoring consultant that introduced her to the benefits of factoring and explained how factoring her invoices immediately after maintenance and window cleaning services were performed would allow her to accept the lucrative contracts offered by both the city and county without worries of making payroll and timely payments to vendors for her cleaning supplies. Bill introduced Betty to a factor's BDO through a conference call and Betty was provided with a Terms and Conditions letter within an hour that offered a factoring arrangement whereby Betty would be charged a flat rate of 5% for 45 days and 1% for each ten days thereafter on all invoices factored. Betty's profit margin of 25% easily absorbed the factor's fee and left her with a 20% margin on work she was currently turning away. And, the benefits from her minority business standing would also allow her to build a slightly higher profit margin into her bids for the city and county's future work. Betty's profit margin of 25% easily absorbed the 5% factor's fee and left her with a net 20% margin on work she was currently turning away. And, the benefits from her minority business standing would also allow her to build a slightly higher profit margin into her bids for the city and county's future work. Betty executed her factoring agreements and established her client relationship. She immediately began to bid on the city and county jobs that she had been turning down for years and was awarded a $25,000 monthly contract to provide maintenance on five local county buildings and also won the bid for maintenance on the City Hall for over $100,000 per year. With her factoring agreement now in place and with no more worries about meeting payroll, Betty's Building Maintenance Service, Inc. is now positioned to grow at an exponential rate limited only by Betty's ability to market and contract with major customers. For many service companies like Betty s, factoring is most often the financing mechanism of choice. 19

Toll Free: 1.888.XPORTSK (9767875) (in North America) Email: inquire@sasktrade.sk.ca www.sasktrade.sk.ca

Toll Free: 1.888.XPORTSK (9767875) (in North America) Email: inquire@sasktrade.sk.ca www.sasktrade.sk.ca These manuals are created as resource guides for members of Saskatchewan Trade and Export Partnership (STEP). For more information on these manuals please contact Saskatchewan Trade and Export Partnership

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