Cash to work with
Debt factoring products and services are steadily gaining traction in a market that has traditionally viewed them with a degree of scepticism. For many businesses they can be the difference between stagnation and growth.
The factoring concept is simple and has been around for centuries. Essentially it allows you to borrow against the value that’s locked up in your debtors list, rather than the traditional approach of borrowing against property assets – which, for most business owners, usually means the family home. It’s also strictly intended for raising working capital – not to fund that new car, boat or bach.
To get a better understanding of when, where and how factoring works best, I paid a visit to Edward McKee Wright, director of Working Capital Solutions. In their new Auckland CBD office he reminds me that less than 60 percent of New Zealand businesses make it past their fifth year of trading, and often that’s due to under-capitalisation.
It’s great that we have an economic environment in which people can give business a go, he says, but many get burnt and end up facing insolvency. There’re just not enough small businesses growing to medium-business level, he adds, “and generally there is only one reason why people go out of business and that’s a lack of money.”
“There may be plenty of symptoms,” he says, “but only one cause.”
Business owners often don’t appreciate how much capital they’ll need to move forward, and they don’t get enough advice on funding options either, says McKee Wright – options such as factoring. He believes that in Christchurch in particular, with its imminent rebuild, there will be a number of businesses, especially contracting companies, that will find factoring ideal for ramping up growth quickly.
[At the time of writing, McKee Wright was also about to announce the company’s purchase of Dash Acceptances Ltd, a long-established factoring company for panel-beating firms – traditional users of factoring arrangements.]
Working Capital Solutions focuses mainly on companies with turnovers of less than $2 million. “When you explain the product to these people, they’re excited to hear about it and know that it will be the solution to their problems.”
Unfortunately, he adds, being human means people only come to you to borrow money ten seconds after they absolutely need to. “And like the ugly kid at the ball, you know you’re probably the last option.” It’s much better to plan your factoring he says, and meet your obligations (tax payments, for example) on time, thereby avoiding penalties.
McKee Wright sounds a caution to potential new clients about the need to watch what they pay in fees to certain “opportunistic” factoring companies. “The most you should ever pay is around five percent – never more than a typical ‘prompt payment’ discount – so check what’s out there.” Fees can go as high as ten percent for 60 days, he says, which doesn’t do much for the market.
I wonder how the local factoring market has been impacted during the recession, and what its overall prospects are, and put these questions to Craig Brown, senior lending manager at one of the industry stalwarts, Lock Finance. He says they’ve plenty of evidence that their factoring business is growing and that general acceptance of debtor finance is on the up.
“For example, a large national accounting firm recently included our funding options as recommendations when appropriate for clients.”
Brown says the past few years have largely been a time of consolidation. “Most companies have survived the recession but they have had to reset their expectations of growth and profit and are cautious to take on additional borrowings. Things will continue to be slow over the next 18 months.
“The finance market is still dominated by the banks and they’ve become more flexible than expected much earlier in the recovery cycle although still heavily biased toward property security. Longer term, when business owners become more confident, we do expect to see a good increase in growth,” he says. Meanwhile he believes providers of factoring products, such as Lock Finance, have also become more flexible since the GFC. “With us there is now the ability to have a tailored mix of [funding] facilities.”
Dave Cooper, GM of Scottish Pacific Debtor Finance (Scotpac), another trusted long-term player in the local factoring market, has seen the recession’s impact on business solvency. But the pressures on the housing market and resulting drop in values has generated new interest in leveraging the debtors ledger to free up instant capital, rather than opting for property secured loans. Enquiries have definitely picked up since mid-2011 he says. “More people are getting that they no longer have to put their home up as security – they can put their business assets up instead. “And remember, nobody will value your debtors book as highly as a factoring company.”
Cooper says factoring arrangements are very easy to set up, and up to 80 percent of your invoice value can be released within 24 hours. “Of course, it’s up to you if you want to draw down – the money is simply available. You can put through a request via our online facility and you pay daily interest only on the balance owing.
He, too, sounds a caution on fees. “There are those factor companies that charge in advance over 60 days. They get a win if the debtor takes longer to pay because they’ll charge penalty interest.”
In short, it pays to shop around.
Getting your head around the various factoring products in the market can be somewhat daunting. For a quick explanation I consulted John Blackmore, national sales manager at Bibby Financial Services, “the world’s largest non-bank provider of invoice finance-related products”. He sums up the current offering under two headings:
• Factoring – The factoring company typically advances 80 percent of the invoice amount (GST incl) and assists the borrower with invoice collection. “This process aids small businesses who have inadequate collection systems and/or simply want to separate the collection process from the people making the sales. In some cases the factoring company will allow the borrower to collect the invoices (typically called ‘partnership factoring’). In all circumstances, though, the factoring solution is also disclosed to the debtor.”
• Debtor/Invoice Finance – This is generally the solution that is undisclosed to the debtor and lenders often just look at the total ledger as opposed to individual invoices. “This solution is typically available to businesses that have revenue in excess of $2 million, and have a good spread of debtors with proven collection history and systems.”
Essentially the choice is between total ledger financing, which includes full service factoring and is fully disclosed to the client’s debtors, and debtor financing which is not disclosed. Is disclosure a problem? All the people I spoke to said it’s almost always never an issue.
Incidentally, Lock Finance has also extended the funding process one step further, where they not only look to finance the invoice, but also the purchase order.
Choosing the right product and provider is perhaps not as cut and dried as the previous summary suggests. There are subtle and not-so-subtle differences.
Working Capital Solutions, as an example, insures its debtors as a requirement of one of its backers, a Barbados-based mutual fund. “We’re the only non-bank financier in New Zealand to have a global debtor indemnity policy. So if your customer doesn’t pay, the insurance repays. For qualifying companies and debtors we are actually buying the credit risk. When our clients pay the factoring fee, it’s also their insurance.
“It’s called non-recourse factoring,” explains McKee Wright, “which is very common in the US, where factoring is much more prevalent, and it allows us to cover the ‘high value’ debtors.
He says in Christchurch, especially, where large, single companies have secured contracts, they’ve been able to take on these “concentration risks”, where all the risk is concentrated in one or two large debtors.
All this is not to say that other factoring companies won’t organise debtor insurance for their clients as well. Scotpac’s Dave Cooper says his company can also arrange such a facility, and it can be a good idea in the current tight economic climate.
Convincing the sceptics
It may not suit every business situation, but used effectively and appropriately, factoring in all its various forms can make a big difference to a firm’s performance.
But how do you convince the sceptics?
“Many accountants and financial advisers suggest that to improve cashflow a company should offer five to ten percent early payment discount to get payments in quicker,” says Craig Brown. “Our costs to provide some working capital finance may only be two to three percent. A company should also consider the opportunities it could take advantage of if it had funds available under an additional funding line. Additional sales at their traditional margin could more than offset any funding cost,” he says.
Over at Bibby Financial Services, John Blackmore reminds me that invoice finance solutions better match working capital funding needs.
“They relate directly to sales. If sales are up, the firm’s borrowing ability can be up too. If sales are down, perhaps through cyclical times or seasonal trends, the borrowing ability is reduced. With a normal overdraft, generally secured by personal property, it’s a set limit,” he says. “Owners have to accommodate their funding needs in times of seasonality.”
A key benefit of factoring, adds Blackmore, is the ability it gives a company to grow and offer its clients payment terms which might otherwise create cashflow issues.
“Some large New Zealand corporates now demand 60 to 70 day payment terms. These are generally large orders as well, so it can have quite a detrimental effect on a business,” says Blackmore. “As an example, an invoice from a large corporate of say $50,000 a month on a 60 to 70 days payment cycle would potentially lock up $100,000 to $150,000 in three months. While the corporate is a “good debtor” it means the small or medium business may not be able to re-order and pay for additional stock. Invoice finance would free up this cashflow.”
(Incidentally, Bibby Financial Services, which is headquartered in the UK, can finance export receivables to markets where Bibby has representation – currently 14 countries including New Zealand. Blackmore says no other non-bank provider offers the same solution without the involvement of third-party providers.)
Dave Cooper at Scotpac believes if you don’t have property as security for a cash loan and you have a strong balance sheet, why wouldn’t you approach a factoring company? He says they can provide reference sites if needed, and keep the arrangement confidential. “Why not turn that money locked up in your debtors list to your advantage? Think of the potential opportunity loss if you don’t.”
Cooper says smaller businesses often appreciate the debt collection assistance that’s part of their service – and everything is kept very transparent with businesses able to see all payment transactions on Scotpac’s secure website. A full factoring service comes with all the trimmings, including full reconciliation of all payments. It’s a complete open item debtor system, explains Cooper, so receipts can be matched against specific invoices and the business knows exactly what’s outstanding at any given time.
Edward McKee Wright says many of their clients are initially surprised at how inexpensive factoring is. “Also people believe that as soon as their customers find out that they are factoring, none of them will deal with them. I’ve never known that to happen!” he says. “Generally speaking what happens is that someone in accounts payable changes who gets paid. And talk to any accounts payable person – they’ll know all about factoring. Your customers probably won’t even know payments are being made via a factoring company.”
Cooper agrees that there’s almost never any instance of debtor alienation – “if you’ve got a good product, they’re happy to work with you.”
Another myth is that you’ll lose control of your debtors, which again, is nonsense says Cooper. “Factoring is very much a team thing, a partnership.” And with two parties keeping a close eye on debtors, any opportunity to assist with money collection can be quickly actioned he says.
Is factoring a sign of weakness? If you can unlock the money tied up in your debtors ledger, that’s an advantage, hardly a weakness, says Cooper. Submit an invoice by 10am with Scotpac and you can have 80 percent paid out that very same day, he says – to buy more stock, meet that tax obligation, pay creditors, whatever your working capital requirement may be.
And don’t look at factoring as a short-term fix, he says. Their average client stays with them for five to six years – they even have one business that has been with them 20 years.
To illustrate the effectiveness of factoring, Dave Cooper pulled the following three case studies from Scotpac’s files.
The first was a freight company that had an overdraft of $400k, was growing rapidly but didn’t have property to secure an increase to the $1 million dollars required. The company had seasonal requirements and Scotpac was able to give them a facility of $1.5 million, secured by their debtors ledger, which gave them more than the bank could come close to giving them, and at a lower interest rate than the banks’ overdraft rate. “They also decided to outsource the debt collection process to us, which has improved their ‘debt turn’ and lets their accounts staff get on with more productive work,” says Cooper. “The facility has allowed them to look at securing more market share, confident that they can fund the growth.”
The second example is a recruitment firm hampered in its growth ambitions because the gap between paying contractors and receiving the fees charged from their customers was applying tremendous financial pressure. “We were able to give a facility that has allowed them to pay their contractors on time while still offering 20th of following month terms to their customers. Their sales can and will easily double in size over the next 12 months.”
Thirdly: a company struggling to keep up with demand for their product because they didn’t have sufficient working capital to buy more stock. “They had to give substantial discounts to customers in order to get money in and buy more stock. We provided a facility so that as soon as they raised their invoices we gave them 80 percent of their value (the other 20 percent is given back once the money is collected).
“They could buy more stock and turn that stock into sales, and we can then advance a further 80 percent on the new sales. The interest and admin fee we charge for collecting the money is substantially less than the discounts they were giving away – and they get their money immediately,” says Cooper.
Working Capital Solutions’ McKee Wright has the example of a Christchurch contractor whose turnover, thanks to the rebuild, went from zero to $600,000 in just two months and took full advantage of invoice funding to manage that growth.
Of course there are many instances when factoring is probably not the best option for a business. It’s about weighing up your costs, says McKee Wright. “If you’re making ten percent gross margin or less, you probably shouldn’t be factoring, by the time interest and fees are taken into account. Most companies operate at around 30 percent gross profit, and that’s where factoring works best.”
He also advises against using factoring to fund anything other than working capital – such as plant or machinery.
Factoring stacks up favourably against the other options for raising working capital – such as borrowing against your house or selling down part of your business, adds McKee Wright.
“Factor if you want to keep your house safe, you want to retain control and you want flexibility.”
He says if factoring isn’t right for a particular business and there’s a more suitable option, they will endeavour to help and advise them with that option.
His final word of advice? “Just as homeowners can be one or two missed pay-checks away from defaulting on their mortgage, without factoring a small business can be one or two bad debtors away from not being able to pay the staff wages. Cash is king.
“If funding is holding back growth, remember that debtors can account for 40 percent of the balance sheet. If you could have instant access to that amount of capital, how much would your business grow?
“And if you’re borrowing at the last minute you’ll probably make a bad decision – so planning ahead is very important.”
Business: GS Pacific Factor company: Lock Finance
GS stands for Global Solutions and it imports and distributes Indian food products. “It is the second business I’ve been able to develop with support from Lock Finance,” says owner Phil Richards (the other being cloud payroll company Smartpayroll.co.nz).
“I bought GS Pacific at the end of 2008 just before the global financial crisis kicked in and life got pretty tough. Because we were buying goods in advance in India and we had to pay for them before shipping, we had a very bad cashflow cycle. It could take up to six months before we were paid and I needed the cash back so we could reinvest in more stock if we were to grow the business.
“By selling the debtors to Lock Finance through their factoring service I was able to get the cash back quickly. The cost of the service was negligible compared to the money I could make by reinvesting in the business. I was able to get a whole bunch of products into the New Zealand supermarket chains and over the space of three years we tripled turnover from $1 million to $3 million and drove the profit from $150,000 a year to more than $750,000.
At the end of the day we were only successful in the business because of the assistance we got from Lock Finance in factoring our debtors.
GS Pacific sold in November 2011 for a healthy profit and Phil’s latest project is building a chain of accounting practices specifically for business owners who want to grow their businesses
What is invoice finance?
There is only one New Zealand bank directly involved in the factoring market. NZBusiness asked Andrew McKerrow, BNZ’s national manager cashflow solutions, to explain how the bank’s ‘invoice finance’ product works.
“BNZ Invoice Finance online is available nearly 24/7 via our Internet Banking for Business system. Access to ‘cash’ is at a click against the invoices a client sells us and we approve – there are no faxes or lengthy waits. The client sends us electronic invoicing direct from their accounting package, so there’s no duplication of data entry either.
“We fund up to 80 percent of the GST inclusive value of the invoices for up to 90 days past due payment, providing access to that vital cashflow and access to cash longer to pay your bills, grow your business and make more money. It’s all confidential in that we don’t talk to your customers, we leave your relationship with your customers with you and we don’t invoice or collect on your behalf, which is what factoring provides.”
Why is BNZ the only bank in the country to be involved in the market?
“Our parent company, NAB in Australia, has provided invoice finance for more than 15 years, understands it and endorses its use on both sides of the Tasman,” says McKerrow. “We understand customers need an alternative to overdrafts and lines of credit, where growth in sales or seasonality outstrips the ability of a company to fund their business adequately day to day, week to week. The trade cycle gets out of kilter with cash being paid back in by debtors. “Cash is needed today to buy more stock, pay wages, pay fuel and weekly bills but the company isn’t getting paid for another 30 to 50 days. This is where traditional bank funding lines don’t work. Invoice Finance does because it grows with a business, is self-funding (sales growth) and self-securing (debtors used as security).”
The invoice finance market is growing. McKerrow says the BNZ has seen growth in customer numbers increase 21 percent and 25 percent in the past two years despite the economic downturn. “We see customers taking the opportunity to restructure their bank facilities, change banks, leverage their business assets (debtors), buy out competitors, remove their personal property from securing working capital funding and grow their businesses,” he says. “Why? To be more successful and reach their business and personal goals using modern methods of funding that match their needs.”
So when does invoice financing work best and in what instances should it not be used?
In a nutshell, it can be used whenever you cannot collect cash in fast enough to cover the need for cash today to cover day to day bills, says McKerrow. “But the product is not suitable when a business has sustained consistent losses or sales drops.”
Before entering into an invoice finance arrangement with a client, the bank requires full ‘financials’ and a completed BNZ Invoice Finance application form detailing how the business operates and the inner workings of the administration of debtors, with any supporting material.
Are there any misconceptions surrounding the BNZ’s invoice financing?
McKerrow says there is the belief out there that they talk to your customers and collect the payments – they don’t. Some people may think it’s expensive – but he points out that facilities are priced similar to overdrafts and match the risk and work involved in administering your individual facility. “To compare it to an overdraft secured against a house or commercial property is not comparing apples with apples,” he says. “The benefits of BNZ Invoice Finance, with more cash quicker to generate more profit, can potentially offset any differential in pricing and/or make you money.”