Why is everyone talking about Factoring and Accounts Receivable Financing in Canadian Business Circles?

There continues to be a fair amount of press about the alternative financing method known by a number of different names – These include Factoring, Working Capital Financing, Cash Flow Financing, Invoice Discounting, etc!! Let’s keep it simple and we’ll just call it factoring for our purposes.

The old cliché that the ‘cheques is in the mail ‘probably has never run more true for Canadian business owners and financial managers. Receivables, on balance, tend to be in most cases either the largest (or pretty close to it) liquid asset of the company, next to cash. And there is never enough cash.

As the economic challenges of 2008-2009 massively affected business credit liquidity all over the world, including here in Canada the other cliché of ‘cash is king’ became even more important. Many business owners we talk to continually say they are devoting too much time to collection of receivables and their working capital issues, rather than focusing on running and growing their business.

We should mention that as Canadian business owner’s work on liquidating their receivables into that much needed cash that it is, many times, the larger corporations that are paying them as slowly as their smaller customers. Larger corporations by delaying payables can increase their own cash flow rations significantly, and the smaller customer or supplier, your firm, has little leverage with such large corporations. (We won’t name any names to protect the innocent!)
Standard payment terms for most industries, more often than not, is 30 days, but it is of course not unusual for suppliers to stretch out to 60 and sometimes even 90 days.

So where does factoring come in. It certainly can be a consideration for Canadian business owners, as it alleviates the problems we have mentioned above – namely high investment in current assets of receivables and inventory, and prolonged delays of payment from even the largest customers.

The ‘factor ‘ purchases the account receivable, withholds a fee for doing that, and advances cash immediately, almost the same day, against those invoices .

Factoring has been around over a hundred years or more, and has gained huge acceptance in Europe and the U.S. – It certainly never caught on in the past to the same degree in Canada as it has in other places. Some analysts estimate that in the U.S. it’s a 100 Billion dollar business, and in Canada it’s a 4 Billion dollar business.

So let’s get back to our core theme – why is everyone talking about Factoring. Again, it’s the instability of the financial markets and the difficulties that smaller and medium sized firms have in arranging ‘adequate’ business financing. We emphasize adequate because yes, it is great to get a line of credit at your bank of say $ 100,000 at current Canadian rates of 5 or 6 per cent per annum, but if you need 300,000.00 and all your collateral is tied up what good does that do – not a lot.

We believe factoring has done when primarily because of the tightening of chartered banks – Business owners go where the money goes, so alternative non traditional financing such as factoring will continue to do well when banks tighten credit facilities
As Canadian business optimism improves, but credit remarkets remain unstable to a certain degree factoring continues to be a solid viable solution. If your firm has assets such as receivables and in some cases inventory or purchase orders the Canadian business owner can obtain immediate cash for those assets. Most of these firms would not qualify for larger term oriented loans with various financial requirements such as other collateral, debt covenants, operating covenants, etc.

Depending on which type of factor facility the Canadian business owner chooses the facility can also reduce his collection and administrative work.

The best candidate for a factoring facility is a high growth firm with good gross margins. That profile is very important. Why is that? It’s because factoring is more expensive than bank financing, so the firm gets all the cash it needs, but margins are eroded by a couple per cent age points. A low margin, commodity type business is not optimal for a factoring solution...
In Canada, as we have noted, factoring is still not widely accepted, in the U.S. it is dominated by a couple of huge players and probably a thousand smaller firms.

In summary, factoring continue to gain traction in the Canadian business financing marketplace. It is more expensive than bank financing, but provides a lot of liquidity that could otherwise not be found. Business owners need to thoroughly investigate this type of financing if they feel it’s appropriate, or engage the services of a trusted financing advisor in this area with credibility and solid partner firms in this area.