Factoring can provide an essential infusion of cash into small businesses strapped for operating capital. Factoring is really only the process of leveraging outstanding invoices owed to you by your customers, and it can ensure liquidity even when customers don’t pay their invoices for 30, 60 or even 90 days after delivery of goods or services. Of course, in order to benefit from this, you’ll need to work with factoring companies. There are quite a few options out there, and they’re not all the same.
Navigating the sometimes murky waters of the factoring industry can be a challenge. Let’s discuss a few of the things you’ll need to know about factoring companies, specialties, and the different forms of factoring that you might encounter out there.
How Do Factoring Companies Differ?
Factoring companies can differ from one another in a number of different ways. These include the following:
- Type of factoring offered
- Industries served
- Industry specialisations
- Fees and charges assessed
- Recourse/non-recourse factoring
Those are just some of the ways that factoring companies can differ from one another. Now, let’s delve into those areas and see how they might or might not apply to your particular situation.
Types of Factoring
In general, when you hear the word ‘factoring’ what’s being discussed is invoice factoring. However, there are other options that might fit better, and there are also other names used for the same processes.
Invoice Factoring: This is the conventional type of business factoring in which you sell an invoice (or a number of invoices) to a factoring company. The firm then gives you an advance on the amount your customer owes. Once the customer pays, the firm then pays the remainder of the invoice balance less a fee.
Invoice Discounting: Invoice discounting is very similar to invoice factoring, but it’s slightly different. In this situation, you don’t actually sell the invoice, and you maintain control of the situation. This is really closer to a loan than anything else.
Export Invoice Finance: While invoice factoring is the most common option for companies doing business strictly within Canada, some do business internationally. In this sort of situation, export invoice finance can help. A factoring company will work with a partner firm in the country in which you’re doing business (overseas). Note that the minimum fee required in these instances can be substantially higher than in a domestic invoice factoring situation.
Maturity Factoring: Maturity factoring is quite a bit different from invoice factoring. In this situation, the firm will take over all of your credit and collection functions. However, you will not see any money until the due date (or after) of the invoice. This is one of the rarest forms of factoring, although you’ll find it available from some companies.
As you can see, there are quite a few different options that fall under the broad heading of “factoring”, and they’re far from being the same thing. You’ll need to tread carefully when choosing between factoring partners, and make an informed decision based not only on accurate information about the company in question, but about your own needs and cash flow situation.
Factoring Companies and Industry Specialisation
While there are generalist factoring firms out there, you’ll find that quite a few specialise in providing services to a specific industry. For instance, you’ll find transportation factoring companies out there, also called OTR factoring companies, as well as manufacturing and warehousing/logistics factoring companies in Canada.
Why consider working with a specialised firm, rather than a generalist company? There are actually quite a few reasons, and you’ll find that each industry has its own peculiarities. Let’s consider the construction industry as a prime example. If you’re in the construction industry and perusing a list of factoring companies, you’ll definitely want to work with a specialist.
This is because construction contracts are very different from other types of accounts receivable. One prime example of this is the “pay-when-paid” clause. Let’s suppose you’re a subcontractor on a construction job. You have a contract with the general contractor that basically says you’ll be paid when (and if) the general contractor is paid.
Trying to sell that sort of contract to a generalist factoring company isn’t going to work, simply because there are too many variables. For instance:
- The general contractor might not be paid by the primary client, or payment might be months later than originally agreed.
- The general contractor might not pay you at all, even if they are paid.
- Construction contracts often involve “progress payments”, which make most factoring companies nervous, simply because there’s a great deal of ambiguity about them (chargebacks and disputes, for instance).
- Different types of companies are generalised as “construction” firms, even though they’re very different and operate in dissimilar ways (well boring companies versus roofing companies, for instance).
Another example can be drawn from the transportation industry. Factoring for trucking companies can provide valuable solutions when cash is low and liquidity is needed, and your clients haven’t paid yet, but there’s a great deal of ambiguity in the trucking/logistics industry (as much or more than the construction industry).
This ambiguity grows if you’re involved in the wider logistics industry, including warehousing. What happens if your customer simply chooses to abandon their stock stored in your warehouse and doesn’t pay the bill? A factoring company that specialises in logistics/warehousing would understand this risk and provide specialised solutions that take it into account.
As you can see, there are many instances in which working with a factoring company that specialises in a particular industry is not just a good idea, but absolutely crucial. Other examples could include research and development firms, scientific research companies and the like. Essentially, any industry that is substantially different from the norm may require specialised knowledge and experience on the part of the factoring firm.
There are additional considerations to be made that a specialise factoring firm might be able to help with, as well. For instance, specialists tend to offer a wider range of services pertinent to your industry than do generalist firms. While this is not true across the board, you’ll find that quite a few factoring companies can provide additional value. For example, a company that specialises in warehouse and distribution/trucking factoring, might be able to provide services that include:
- Credit reports
- Online reporting
- Fuel card programs
- Digital invoice processing
- Non-recourse factoring
Different Options Offered by Factoring Companies
In addition to specialisations, you need to consider other elements before choosing between factoring companies out there. These elements primarily revolve around the company’s policies and practices involving invoices and your clients or customers.
Recourse Factoring: Recourse factoring is the most common option out there, but it might not be the best fit for your needs. In this situation, you’re on the hook if your client pays their invoice late, or fails to pay completely. That means you might be required to repay the advance initially provided by the factoring company.
What will you do if you’re already spent part or all of the advance? Considering the fact that it might be up to three months from the point that you factor the invoice to the time the client is required to pay, there’s a lot of potential for that money to be spent. If your client doesn’t pay and the factoring company demands the money back, how will you do so?
Non-Recourse Factoring: Non-recourse factoring is less common than recourse factoring, and for good reason. It’s a lot riskier for factoring companies. This is essentially the reverse of a recourse factor, in that you’re not responsible for late payment or nonpayment by your customer. The factoring company will be responsible.
While that sounds like a great deal on the surface, we urge you to look a bit more closely at the contract you’ll be required to sign. Factoring companies offering non-recourse financing are taking greater risks than those offering recourse factoring, and their fees will be commensurately higher. You may also find that there are additional charges tacked on to further limit the risk the company faces. In the end, this can be more expensive than recourse factoring.
Non-Notification Factoring: In most cases, factoring companies will inform your customers that you’ve sold their invoice, and that the factoring company will be collecting the unpaid bill. That may or may not be a problem for you. It really depends on your needs, and your clients or customers. If discretion is necessary, then non-notification factoring will be a better fit.
Again, this isn’t offered by all factoring firms out there, so you’ll need to shop around and compare your options. It’s also worth noting that non-notification factoring is generally more expensive (higher fees) due to the greater amount of work needed on the factoring company’s end to ensure confidentiality.
Considerations to Make When Comparing Factoring Companies
Factoring can be a powerful solution if your business is facing a shortfall in cash. It offers the ability to obtain liquidity, without the need to work with a bank (and suffer the lengthy wait times, and the very real possibility that you’ll be turned down). Also, factoring is not a loan – it’s an advance on cash already owed to your company. So, you’re actually just selling an existing asset.
With all that being said, you do need to compare your options very carefully. While there are reputable factoring companies that have been around for a long time, there are also less-than-reputable firms that you should avoid. When comparing your options, you’ll want to consider a few things, including the following.
How long has the company been established? A lengthy history is a good sign that the company is on the up and up, and provides a valuable service to its customers. While you may consider working with a younger firm, the lack of history can make it more difficult to determine if they’re worth your time.
Factoring Types Offered
As we’ve discussed, there are many different types of factoring out there, and they can be very different. First, define your needs, and then find a company that offers solutions that fit your needs.
Fees and Charges
Factoring does come at a cost. All factoring companies will charge you a fee based on the amount of the invoice being factored. However, some companies tack on other charges – application fees, processing fees and other costs. It’s obviously in your best interests to make sure that the company you’re working with doesn’t add hidden fees to your contract, or you could find yourself overpaying for the service.
This may or may not apply to your business – it really depends on your industry. However, for businesses in quite a few different industries, specialisation is not just “nice to have”, but an absolute must. What’s more, it can be difficult to tell if a company actually focusses in your industry, or has only handled a few transactions in that area. Look for industry-specific knowledge, and ask for a list of other clients the company has served in your industry before you sign on the dotted line.
Get the Help You Need
Finding the right option from the many different factoring companies in Canada can be time consuming and difficult, especially if you have little or no experience here. We can help. We invite you to take advantage of the free consultation with one of our factoring specialists and learn more about which companies are the right fit for your needs.