Asset-based financial services organizations (asset-based lenders) play a vital part in financing the economy and are dedicated to the growth and well-being of their clients. They provide their clients with cash by lending on fixed assets, accounts receivable and inventory, and engage in factoring, purchase order financing, real estate financing and leasing. They include the asset-based lending arms of domestic and foreign commercial banks, small and large independent finance companies, floor plan financing organizations, factoring organizations and financing subsidiaries of major industrial corporations.

Expert in all facets of collateralized lending, asset-based lenders – large and small alike – possess the experience and know-how to structure the proper financing program for their borrowers. They specialize in financing businesses and business transactions involving a broad range of products and services, both domestically and internationally. They provide:

Operating cash

Funding for an acquisition, a merger or a leveraged buyout

Debt consolidation

Turnaround financing

Bankruptcy/reorganization financing

Equipment financing

Inventory financing

Floor plan financing

Equipment leasing

Import/export trade financing

Growth financing

Factoring services

Growth Money

Businesses need money to grow. A business cannot survive just because it has a better product, an exclusive market or the best method of distribution. The catalyst required for progress is money.

Business owners and managers must be knowledgeable about financing, what it can do, why one form may be better than another. It can be used when:

Operating cash is tied up in receivables

The best trade terms for supplies create cash flow shortages

Inventory levels are high because of client demands

Sales growth is straining resources

Seasonality peaks cause problems

No fixed assets are available for collateral

Trade discounts and special pricing terms cannot be obtained

Letters of credit are required to supply or buy overseas

Debtor-in-possession financing is required

Asset-based lenders often advance funds when traditional sources are not available. They are familiar with various types of businesses and are responsive to client needs.

Loan size

Asset-based lenders fund businesses with annual sales less than $25,000 to more than $1 billion. Credit depends on the type of business and the content and quality of the collateral. Frequently, the credit granted is more than the net worth of the business.

The increased cash availability provided by asset-based lenders often makes the difference between profitable growth and failure for the undercapitalized business.

The phrases "too small," "too new," and "not enough net worth," do not deter an asset-based funding source.

The flexibility and cash availability provided by asset-based financing have enabled countless companies to grow and take advantage of market opportunities.

Cost

The cost of asset-based loans is influenced by the credit risk and collateral associated with the transaction. When evaluating an asset-based loan, borrowers should assess the cost of financing in the context of the benefits to be received. Compared with other financing alternatives, asset-based lending is very cost effective and efficient.

Asset-based lenders frequently look beyond financial statements to determine how much money they are prepared to advance at and after closing. Therefore, borrowers can take advantage of profit opportunities in the market by being able to plan ahead based upon their cash availability.

Asset-based lenders are proactive rather than reactive and can often restructure debt during tough times to help avoid costly and disruptive refinancing.

Over the long haul, the benefits will tend to offset the premiums associated with borrowing from the asset-based financial services industry.

Types of Asset-Based Financing

Secured lending

The lender provides funds secured by the assets of the borrower. The collateral can include: accounts receivable, inventory, machinery, real estate, patents, trademarks or other assets where value can be determined.

The secured lender may establish a revolving loan where the borrower provides a pool of collateral that the lender translates into operating cash or working capital. The borrower uses the financing to buy more materials, expand marketing, improve productivity or other improvements and sells the resultant product. The sales create receivables that are pledged for cash advances and the payments received on the invoices pay down the loan. These increases and reductions in the loan balance are cyclical, hence the revolving nature of the loan.

Some receivables have less collateral value, for example, progress billing, past due receivables, and receivables subject to "set-off". Raw materials and finished goods are normally acceptable collateral, but work-in-progress generally is not. Equipment and real estate may also be used as a source of financing.

Non-recourse factoring: The financing institution buys the receivable and assumes the risk of customer credit. The factor guarantees against credit loss, unlike a secured lending facility. The factor will also check credit, undertake collection and manage bookkeeping functions.

Full-recourse financing: The financing institution accepts assignment of the receivable but does not assume the credit risk. The client retains responsibility for managing the receivable portfolio. Generally, the lender will finance invoices up to ninety days from delivery of goods or services, then charge them back to the client.

Discount factoring: The factor purchases the receivables at a discount to compensate for paying prior to the due date.

Maturity factoring: The factor purchases the receivables, assumes the credit risk and advances cash to the client as the invoices mature.

Non-notification factoring: Account debtors are not notified of the sale of the receivables and the invoices are either paid to a lock-box or to the shipper. This is similar to a receivable loan.

Notification factoring: Account debtors are notified of the purchase of the receivables and are directed to make payments to the factor.

Spot factoring: A "one shot" transaction, generally out of the normal course of business.

Floor plan financing: Certain industries require significant high-priced finished goods inventory. Examples: automobiles, refrigerators, washing machines, televisions and stereo systems. These are supplied on extended credit terms to retailers. Retailers usually do not purchase this expensive inventory outright; rather a finance company will provide credit to purchase the inventory, secured by the product "on the floor".

Leasing: The lessor purchases the equipment needed to fulfill certain obligations and the equipment remains the property of the lessor even after all the borrowed funds are repaid; or existing assets are sold to and leased from a leasing company to release capital needed for working capital purposes.

Purchase order financing: Working capital financing is secured by a security interest in existing purchase orders and the proceeds of the purchase orders. Normally the security interest is perfected by the lender taking possession of the inventory or raw materials.

Real estate financing: the mortgaging of land and/or buildings to raise working capital.

Accessing finance can be a real problem for many small businesses, especially if they are growing fast. One option many businesses don't consider is factoring, or cash-flow lending as it is sometimes called.

While not suitable for every business, factoring can provide a revolving line of credit and a reduction in administrative costs.

Factoring involves the sale of a business' book debts on a continuing basis. Usually, the factoring firm will buy the business' sales invoices at a discount of between 70 and 90 percent. The factor then collects the invoice amounts from the business' customers. The business receives the cash, less the discount, from a credit sale quickly (usually within 24 to 48 hours) and maintains a healthy cash-flow even though the debtors may not pay for the sale for another 60 days or so.

Usually, the factoring firm takes the difference as profit; however some factor companies prefer to provide a percentage up front, the remainder on collection, and charge interest and fees on the transaction.

The use of credit cards in the retail industry is a form of consumer factoring, where the retailer is paid immediately for goods or services and the credit card company collects the payment from the customer. Some US banks offer asset-based cash-flow lending but have generally found limited interest in the products - with many businesses put off by higher interest rates charged to reflect the risk of lending against assets not secured by property.

Several Options

Factoring firms can offer several levels of service. The premier service usually involves taking over the complete management of the business' accounts receivable, including administration, confirmation, and collection of invoices, regular reports and monthly ageing reports on all accounts processed.

This is usually coupled with a seamless, confidential service, where the customer of the business is unaware of the relationship between the business and the factor and all communication between the factor and the customer is branded as the business. In other cases, the factor may only take over aspects of the accounts receivable function.

The level of service provided by the factor is often related to the value of the debtors book.

While it may appear complicated at first, outsourcing accounts receivable can significantly reduce costs. More importantly, it is particularly useful for businesses that are growing or moving in a different direction with a view to improving profitability. A growing business can quickly outgrow an overdraft secured by fixed assets, yet it may not be able to obtain finance on an unsecured basis.

A business may also need the flexibility to cover sudden increases in order levels. Factoring provides funding in line with sales growth.

This form of finance can also be useful for start-up businesses that need to pump cash back into their business to build their inventory, but have difficulty obtaining overdraft or working capital facilities due to a lack of trading history.

Service, manufacturing and wholesale businesses are often suited to this type of finance.

Businesses that mainly sell on cash terms to the general public may find credit cards or overdrafts more cost effective. Those with complex products or terms of sale such as trial and return clauses or those in the construction industry, where customers are invoiced in stages, are also less suited to factoring due to the complexity of the supplier/customer relationship.

Pros & Cons

As with all business finance, factoring offers advantages, disadvantages and potential pitfalls.

The level of benefit from factoring will vary from business to business.

But it usually provides:

* Immediate cash-flow access to 70-90 percent of the value of debtor invoices.

* Working capital for growth without requirements for a strong balance sheet or substantial net worth.

* A good interface with the supplier and, as a result, a seamless transaction for the customer.

* Outsourced debtor administration and associated cost savings.

* The ability to increase sales by offering credit which the business may have been unable to fund otherwise.

* The ability to take advantage of creditor discount terms, improve credit rating by being able to pay creditors promptly and an enhanced ability to capitalize on larger orders as required.

* The option to free up property from being tied as security.

Some issues that should be considered if looking at factoring as an option include:

* Complexity. Rather than simplify the account-keeping, factoring may add complexity to the business depending on the level of integration of account-keeping processes.

* Culture. If the culture of the business and the factor are at odds, the arrangement may interfere with the relationship with customers.

* Bad Debts. In most cases, the business still wears the non-collection risk and may end up following a restrictive process to maintain the facility.

* Cost. It can be expensive depending on the interest and costs charged by the particular firm such as finance charges, administration charges, mailing charges, etc.

* Asset control. Some factors take a floating charge over all the business' assets not just debtors. Consequently a business may need to obtain a release from the factor to sell any of its assets.

* Value. The factor may only finance a percentage of the debtor value and may undertake its own audit of the business' accounts.

* Customer relations. Some factors will take over the entire debtor ledger which may cause difficulties if a business wishes to remain in control of some accounts that are particularly sensitive or vital to the business.

* Security. Some factoring firms now require small businesses to provide property as security in which case it may be cheaper and more effective to arrange a bank overdraft.

One of the most common traps for small businesses using factoring is the assumption that outsourcing the function means outsourcing the responsibility.

The benefit of using a factoring facility still depends on good management of debtors and the finances of the business. Every business must manage their terms of trade, and ensure the terms they offer and the credits they receive are appropriate for their particular business. They need an effective debt collection system and simple internal controls to prevent errors.

Factoring could cause additional problems for businesses without a good handle on cash-flow management and cost budgeting. They may find themselves in a downward spiral, spending debtor receipts on current overheads and not paying the current creditors and then wondering what went wrong. They need to understand the money flow of the business and use short-term funding such as factoring on short-term assets.

With good management, the use of factoring can be a very useful source of finance particularly for a young business that is growing fast. However, there are plenty of traps for the unwary, and as always, if in doubt get advice before committing to any form of finance.

Copyright © 2007 Gregg Financial Services