Selecting a Factoring House
What you expect of them
What they expect of you
This is a big topic, so let’s take a hypothetical business and follow its progress in finding a factor.
John Edwards owns an auto parts and repair shop, JE Automotive. He loves what he does, and he’s good at it. Unfortunately, he needs to pay his inventory on a 30-day basis. But some of his customers are not able to take care of major parts and repairs in a single payment. And he has a couple of large business customers for whom he provides service on a fleet of vehicles. Even if they pay on a 30-day basis, he winds up carrying several thousand dollars a month for each of them.
Therefore, he’s decided to sell his receivables. He wants to find a place that will take much of the A/R process out of his way so he can focus on what he does best. He’s looking for a place that will do the following:
- Turn the money around in a very short time. He needs to have only a few days delay from the time he sends the invoices until the money is deposited into his bank account.
- Handle the A/R procedures. He wants someone to send his statements and do any follow up collecting needed.
- Help him expand his business. When the factoring house takes care of all the detail work on his A/R his human resources can be freed to do other things – like taking care of immediate customers.
Take a small discount. The discount on his invoices might be as small as 2% or as large as 20% — depending on how much risk the factor is willing to assume. To get the smaller percentage, he will probably have to find a “full recourse” factor.
With these goals in mind, John sets out to find a factor. While looking on-line and in ads is one way to go, he is better advised to seek out people who are currently using a factoring house.
And he might be surprised just who those people are. The hardware store three blocks down uses a factor, as does the service station across town.
Once he has received recommendations from people he knows and trusts, John is ready to contact the factor he’s chosen.
Daily Dough is a factoring house that’s been in business for more than fifteen years. They handle a large number of businesses – very similar to John’s – including the hardware store three blocks down. Because Jim at the hardware store has had a successful relationship with Daily Dough for more than five years, John decided to contact them.
Dave Byers took John’s first call to Daily Dough. He advised John that Daily Dough will accept his invoices at a 2.5% discount, that turn around time on funds is 2-4 working days, that invoices will be processed the day they are received, but that bank transfers sometimes take two or three days to be completed.
What Daily Dough requires of its clients is:
- A signed contract setting out all the particulars of the agreement between Daily Dough and JE Automotive.
- A subordination agreement giving Daily Dough the right to collect receivables. A subordination agreement is a legal document which says that Daily Dough has the right to collect the invoice amounts from JE Automotive’s customers.
- A set of annual financial records showing the creditworthiness of JE Automotive and John himself, since this business is a sole proprietorship.
- A current client list complete with addresses and phone numbers for contact.
- Regular deposits of invoices – daily or weekly.
- Prompt buy back of invoices deemed uncollectible.
- Maintenance of a reserve savings account to handle the contingencies.
Dave explains that they are a full recourse service. They can accept the small discount on invoices because they do not carry the full risk of skips or bankruptcies. But he also emphasizes that John can minimize the risk of skips and/or bankruptcies by being selective when extending credit.
Daily Dough offers a credit check service which John can access before extending credit of any substantive amount to new customers. And there is no charge to John when he requests the credit report on potential customers.
Dave also suggests that when John sends his deposits, he indicates an amount equal to the discount for deposit in a reserve savings account to build the account to 25% of John’s total outstanding invoices. This provides a buffer for contingencies.
The reserve savings account belongs to John, but provides Daily Dough with immediate access to cover such things as a cash payment on an individual account given to John too late in the month to be reflected on the next statement.
For example, John might call Dave with the information that Bill Rogers has paid his account balance of $1354.76. But statements are being run tomorrow, and that check will not arrive in time to be reflected on the statement.
John would authorize Dave to apply $1354.76 to Bill’s account from the JE Automotive reserve savings account. Then when Bill’s check arrives in the mail, it will be deposited into John’s reserve savings account to replenish it.
So John sits down to analyze whether to sign with Daily Dough or not. On the one hand he gets the following:
- Immediate 95% cash flow within 4 days.
- Someone to check the creditworthiness of his potential customers.
- Someone to handle statements – printing, postage, collections, the works.
- Weekly and monthly reports of the status of accounts.
After the initial set up of JE Automotive as a client of Daily Dough, he will be expected to provide:
- Regular deposits of invoices – either daily or weekly depending on the volume of business.
- Current contact information on all customers.
- Regular maintenance of an adequate savings account balance.
- Annual financial reports.
In addition, John sees how letting Daily Dough do the monthly statements and all the subsequent collections will free up his office personnel to assist with counter sales. Because Daily Dough can offer extended terms to some of his customers, John will be able to service customers he might not otherwise get. When he adds up the score sheet, he decides to give Daily Dough a try.
Is there a Daily Dough in your future?
For additional information, you might like to try the following links:
Buyer Links
Match Factors
Business.Com
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