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Factoring is a convenient lending solution that has become popular with small to medium Canadian businesses that have not accumulated the collateral for a conventional business loan. Factoring receivables may be a good solution for you if you have a thriving a business but need to free up your cash flow while you wait for your customers to pay for your purchase orders. Waiting for payment on your purchase orders can sometimes take as long as 60 or 90 days.
Purchase Order Financing
Purchase order financing is a type of factoring often called invoice factoring. It is not a traditional business loan because the transaction relies on the sale of the purchase orders you send to your customers. The good news is that you can finance your business based on using your purchase orders as proof of the projected income from your clients. This means you no longer have to wait for your customers to pay their invoices before you can receive payment. This immediately frees up your cash flow for investments, payroll and other necessary business expenses.
One of the benefits of purchase order factoring is that your line of credit increases as your business grows so that you can expand immediately as your customer base grows without having to wait for your purchase orders to be paid. You no longer need to be held back by slow or overdue purchase orders.
The finance company to which you sell your purchase orders becomes the factoring company. The factoring company looks at the financial status of your customers, your accounts receivables practices, the overall economic stability of your company and the business knowledge of your company’s owners.
The time it takes to set up your purchase order factoring is only about one week. Once the factoring company buys your invoice, you can expect to receive payment in two separate installments. In your first installment, you receive an immediate advance which is payable as soon as you sell the financial institution the purchase order.
What to Expect
You will usually receive between 70 to 90 percent of your purchase order. The factoring company then collects the money from your customer. Once your customer pays the factoring company, you receive a second payment called the rebate that contains the remainder of your purchase order minus a small fee that the factoring company works out with you.
The fee that the factoring company charges for your financing line of credit depends on how many purchase orders they have with you and the credit worthiness of your customers. The monthly fee you’ll pay is generally between 1.5 percent and 3.5 percent per month.
Factoring your purchase orders is a proven way to provide stability and improve the growth of your company. It also solves the problem of slow paying customers by supplying a third party who can pay you almost immediately and also remove the headache of bill collection.
Another type of financing, called asset-based financing, combines purchase order factoring with other assets you may have. Asset-based financing offers you greater flexibility and more credit than just purchase order factoring and is best suited for medium to large companies. Asset-based lending provides tailored solutions that may or may not include financial covenants and the underwriting of substantial transactions.
Flexibility for Your Business
Many Canadian businesses could benefit from asset-based financing, especially if they are involved in industries where business is cyclical or seasonal, leaving them with high operating margins during certain times of the year and corresponding low operating margins at other times.
Many businesses encounter growth opportunities where they need to act quickly to acquire new inventory to push sales or acquire new assets to meet demand. When the boom is over, these companies often need help to finance their debt, restructure or seek turnaround financing.
With asset-based lending, you can use the collateral you acquired during your busy season to finance your down times and keep payroll and other necessary expenses paid. It also allows you the flexibility to use accounts receivable factoring to improve cash throughout the year.
If the need arises to negotiate a large transaction, asset-based financing also gives your company the freedom to negotiate financial covenants with formal underwriting.
Asset-based Lending Versus Traditional Lending
When a company looks at asset-based lending, they are able to use both their liquid and fixed assets as collateral for their loan. The liquid assets of a company comprise their accounts receivables and their inventory while their fixed assets consist of the property they own, such as equipment and buildings.
Traditional lending first considers a company’s cash flow and then looks at their collateral. A traditional loan is formally underwritten, and relies on being repaid through the company’s cash flow. Therefore, they put financial covenants in their paperwork, but are not as concerned about collateral controls and monitoring of the business.
A company that has acquired many assets over the years, but may be experiencing a slowdown in business, would benefit more from an asset-based loan because it does not require proof of future cash flow. Since asset-based lending doesn’t need the covenants of cash flow based traditional lending, it offers more flexibility to more borrowers.
How a Revolving Loan Helps Canadian Businesses
Using their inventory and purchase orders or accounts receivables, a company can take out a revolving loan that allows them to convert their assets into working capital.
The lender receives a security interest in the accounts receivable and the inventory of the borrowing company and charges the borrower a percentage rate for the money which they advance them. As the borrower’s customers pay their purchase orders, the borrower pays this money to the lender to pay for their loan.
If the borrowing company needs more cash, they request another advance from the lender. The lender oversees the entire collateral in order to offer the company the maximum amount of cash possible. The borrower’s customers are unaware that their transactions are being handled by a third party lender, and they pay the borrower.
The Benefits of Revolving Credit
When a company holds a revolving credit agreement with a lender, the amount of money they owe differs from day to day. If they had a term loan, the amount that they would owe is fixed for the stated period of the loan. This could be as short as one month or as long as 10 years. Most term loans have a stated payment schedule and cannot be borrowed again. However, a revolving loan allows a company to borrow and re-pay several times during the life of the loan.
Revolving loans allow a company to use its current assets to generate cash flow for immediate needs, such as fluctuations in business cycles. Secure loans use fixed assets, such as buildings and equipment, to purchase long-term needs that will help the company for years to come.
Asset-based loans use both revolver and term loans to help a company with its business. When a company takes out a term loan in addition to a revolver loan, they are able to use the total value of their business in order put it into immediate use. The term loan takes into account a particular percentage of the liquidation value of the machinery and equipment on hand or the fair market value of the land and buildings.
How Asset-based loans Finance Acquisitions
If your company is looking to expand its operations by acquiring another company, an asset-based loan can often help with this. You should look to acquire another company that has account receivables and assets that weigh favorably when regarded together with the purchase price of the company.
How asset-based loans Grow with Your Business
Asset-based loans grow as your business grows because then can be based on the assets that expand along with your business. As your inventory and accounts receivables grow, you can also expand your business to meet the new volume of accounts.
Use Asset-based Lending to Plan for the Future
The beauty of asset-based lending is that you don’t have to show a profit when you borrow nor do you have to prove a certain net worth. If you have liquid and fixed assets and knowledgeable leadership, then your company could qualify for an asset-based loan.
There are many customizable solutions that you and your lender can come up with using asset-based lending for your company in Canada. If you need working capital, it’s time to look forward to building your company, rather than becoming pessimistic about the future. Contemporary lending laws in Canada have made it possible to build a better company for you and your employees today.