The Green Sheet Online Edition
January 09, 2017 • Issue 17:01:01
Accounts receivable factoring
In my tenure as quarterback of the Street SmartsSM column, I've focused on various ways in which merchant level salespeople (MLSs) can rebrand as professionals who offer distinct expertise and products tailored to fill specific merchants' needs. Two of the topics I discussed early on were merchant cash advance and alternative business loan products, which are forms of alternative debt financing.
This article delves into another type of alternative financing: accounts receivable (A/R) factoring. Following is a look at its history and function, as well as strategies to lead-in with this solution, which has an over 400 year old tradition.
The creation of accounts receivables
Many of the nearly 30 million businesses in the United States have to deal with customers taking anywhere from 10 to 120 days to complete full payment after a service has been rendered. This practice takes place due to market pressures and the competitive nature of the industries the merchants are operating in.
The official name for a 10- to 120-day outstanding payment is an accounts receivable, which is a claim a business holds against a customer, creating an asset on the balance sheet of the business based on the value of the receivables outstanding.
The act of allowing a customer 10 to 120 days to provide payment is known as Net D or what's known as trade credit. Trade credit is perhaps the biggest source of financing used in the country today; customers are usually provided a discount if they pay their invoices in full before the deadline.
For example, a builder that provided service for a merchant issues an invoice for, let's say, $10,000 with terms that list "5 percent 20, net 30." This represents an invoice due in full within 30 days, but if it's paid within 20, a 5 percent discount is provided. The outstanding invoice becomes an accounts receivable, which is listed on the balance sheet of the builder as an asset.
To assist with cash flow issues stemming from having to wait 10 to 120 days to receive full payment, merchants can utilize A/R factoring, which dates back to the 1600s, when colonists would advance payments on raw materials being shipped to and from England.
The merchant cash advance (which I discussed in a Street SmartsSM article titled "The Merchant Cash Advance," The Green Sheet, April 25, 2016, issue 16:04:02) was founded on the principles of A/R factoring, where you have a factoring company (the purchaser) and a merchant selling his or her balance sheet accounts receivables/invoices (the seller).
The factoring company buys the receivables off the merchant's balance sheet, advances about 70 percent of said purchase amount upfront to the merchant to use for cash flow, then provides the remaining 30 percent at the end. This is after the client(s) have completed their payment cycle (up to 120 days) minus about a 2 percent discount fee the factoring company uses to make money from the transaction.
This type of factoring is known as non-recourse because the risk of non-payment is on the factoring company after it purchases the receivables. In recourse factoring, the merchant (seller) holds the risk of the receivables not performing even after the merchant has sold the receivables to a factoring company.
A/R versus P/O financing
Instead of selling receivables, a merchant could choose to leave them on the balance sheet and use them as collateral for a working capital loan. This would fall under a broad category of asset-based lending and usually be provided by finance companies like those involved in factoring arrangements. They usually evaluate assets such as real estate, inventory, luxury cars, art, equipment and, of course, accounts receivables and approve about a 70 percent loan-to-value ratio of assets pledged.
Purchasing order (P/O) financing is used before accounts receivables are created, as a merchant might have to purchase materials to render services, but not have the capital to purchase said materials upfront. The merchant may, however, have an outstanding purchase order for a service a client wants the merchant to provide.
In this situation, a finance company would advance to the merchant the capital needed to purchase the materials. Once the merchant receives the materials, renders the service and collects payment for said service, the finance company is paid from a portion of the revenue the merchant receives on the transaction.
If you seek to rebrand to lead in with A/R factoring, A/R financing or P/O financing, industries for you to target would include some of the following, based on the fact that many of these industries bill using the Net D approach:
- Oil and gas
- Government contracts
It might be difficult to tie in merchant processing directly to these solutions; however, you can partner with a finance company to offer them as a value-added service. Your sales commission from the finance company might be 15 percent of the revenue generated. So on a factoring deal, if a $25,000 invoice is purchased with a 2 percent discount rate, the finance company would generate $500, and you would be paid $75 (15 percent of revenue) on that transaction.
Even though A/R factoring has been around for over 400 years, many companies experience cash flow issues due to the Net D procedure and have no awareness of factoring. This presents an excellent opportunity as you rebrand from being an MLS leading in with free terminals and processing rate savings to instead leading with various forms of alternative debt financing.
Doing so would help you become more of a profit center to a merchant, not just a cost center. This is what GS Online MLS Forum Member Dee Malik recently spoke about in a forum discussion.
"After all the success and all the years that we have been a part of this space, the merchant looks at us as only a cost center rather than a profit center," he wrote. "How is that possible when we offer core services that may indeed make up their profit margins? The only fighter I've ever watched that could sting you while backing up is Ali. We need to throw punches while advancing our offerings."
Dee Malik's point is that we ought to continue to find new products and solutions that help develop a merchant's business, rather than just find ways to cut meat off the bone (reduce our prices) while doing nothing to enhance quality. I agree with Dee Malik. And leading in with solutions such as A/R factoring to help resolve cash flow issues is surely a step in the right direction.
For additional articles I've penned on rebranding as an alternative financing professional, see two Street SmartsSM articles: "The alternative small business loan" and "The alternative financing rebranding wrap up," The Green Sheet, May 9, and June 27, 2016, issues 16:05:01 and 16:06:02, respectively.
John Tucker has over 10 years of professional experience in commercial finance and business development. He is also an M.B.A. graduate and holder of three bachelor's degrees in accounting, business management and journalism. To connect with John, please send him a connection invite via LinkedIn at www.linkedin.com/in/johntucker99 or email him at firstname.lastname@example.org.
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