Accounts Receivable Financing: Don’t Worry, Be Happy
There’s a reason accounts receivable financing is a 4,000-year-old financing technique: It works. Accounts receivable financing, factoring, and asset-based financing mean the same thing as they do in relation to asset-based lending: the invoices are sold or pledged to a third party, usually a commercial finance company (sometimes a bank) to accelerate cash flow.
In simple terms, the process follows these steps. A company sells and delivers a product or service to another company. The customer receives an invoice. The company requests financing from the financing entity and the financing entity transfers a percentage of the invoice (normally 80% to 90%) to the company. The client pays the invoice directly to the financing entity. The agreed fees are deducted and the rest is reimbursed to the business by the financing entity.
How does the client know that he must pay the financial institution instead of the company from which he receives the goods or services? The legal term is called “notice.” The financing entity informs the client in writing of the financing agreement and the client must accept this agreement in writing. In general, if the customer refuses in writing to agree to pay the lender instead of the company providing the goods or services, the lender will refuse to advance funds.
Why? The main security for the financial entity to be reimbursed is the solvency of the client who pays the invoice. Before the funds are advanced to the company, there is a second step called “verification”. The financial entity verifies with the client that the goods have been received or the services have been performed satisfactorily. In the absence of dispute, it is reasonable for the financing entity to assume that the invoice will be paid; therefore, funds are advanced. This is an overview of how the accounts receivable financing process works.
Unannounced accounts receivable financing is a type of confidential factoring in which customers are not notified of the business financing agreement with the financial institution. A typical situation involves a business that sells inexpensive items to thousands of customers; the cost of notification and verification is excessive compared to the risk of non-payment by an individual customer. It simply may not make economic sense for the financial institution to have multiple employees contacting hundreds of clients for a financial client’s transactions on a daily basis.
Non-notification factoring may require additional collateral requirements, such as real estate; You can also demand a superior credit from the borrowing company with personal guarantees from the owners. Factoring without notice is more difficult to obtain than normal accounts receivable financing with notice and verification provisions.
Some companies worry that if their clients find out that a commercial financial institution is factoring their accounts receivable, it could damage their relationship with the client; maybe they can lose the customer’s business. What is this concern, why does it exist and is it justified?
The MSN Encarta Dictionary defines the word concern as:
“To worry
verb (past and past participle wororied, present participle wororying, 3rd person present singular worories)Definition:
1. transitive and intransitive verb to be or to make anxious: to feel anxious about something unpleasant that may have happened or may happen, or to make someone do this
2. transitive verb to annoy someone: to annoy someone by making insistent demands or complaints
3. transitive verb try to bite animal: try to hurt or kill an animal by biting it
a dog suspected of worrying the sheep
4. transitive verb
Same as worrying about
5. intransitive verb proceed despite problems: persistently proceed despite problems or obstacles
6. transitive verb touch something repeatedly: touch, move or interfere with something repeatedly
Stop worrying about that button or it will come off.
noun (plural concerns) Definition:
1. anxiety: a disturbing and troublesome feeling
2. cause of anxiety: something that causes anxiety or worry
3. anxiety period: a period spent feeling anxious or worried…”
The opposite is:
“don’t worry used to tell someone that something is not important and need not be a cause for concern (informal)
It is not to worry. We’ll do better next time.
don’t worry UK Australia New Zealand used to say something is not a problem or not worth mentioning (informal).”
Query: If a business finances its invoices with accounts receivable financing, is this an indication of financial strength or weakness? Inquiry: From a customer standpoint, if you’re buying goods or services from a company that’s factoring your accounts receivable, should you be concerned? Question: Is there an answer to these questions that fits all situations?
The answer is that it is a paradox. A paradox is a statement, proposition, or situation that appears to be absurd or contradictory, but in fact is or may be true.
Accounts receivable financing is both a sign of weakness with respect to cash flow and a sign of strength with respect to cash flow. It is a weakness because, prior to financing, funds are not available to provide cash flow to pay for materials, salaries, etc. and it is an indication of strength because, post-financing, cash is available to facilitate the growth of a company’s cash needs. It is a paradox. When properly structured as a financial tool for growth at a reasonable cost, it is a beneficial solution to cash flow shortages.
If your entire business relied on one vendor and you were notified that your vendor was factoring your accounts receivable, you may have a legitimate concern. If your only supplier were to go out of business, your business could be severely compromised. But this is also true whether or not the supplier uses accounts receivable financing. It is a paradox. This involves questions of perception, ego and character of the personalities in charge of the business and the provider.
Every day, every month, thousands of customers accept millions of dollars worth of goods and services in contracts that involve accounts receivable notification, verification and factoring. For most customers, receivables financing “notice” isn’t a problem—it’s simply a change in the payee’s name or address on a check. This is a job for a person in the accounts payable department to do a minor administrative change. It is a dominant business practice.
Bobby McFerrin wrote and performed a song called “Don’t Worry, Be Happy” for the movie “Cocktails” starring Tom Cruise. The song was a number one pop hit in the United States in 1988 and won the Grammy for Best Song of the Year. Here are the lyrics:
“Here’s a little song I wrote
You might want to sing note for note
do not worry Be Happy
In every life we have some problem
When you worry you do twice as much
Do not worry Be Happy……
I have no place to lay my head
Someone came and took your bed
Do not worry Be Happy
The landlord says your rent is behind
I may have to litigate
Do not worry Be Happy
Look at me, I’m happy
Do not worry Be Happy
Here I give you my phone number.
When you worry call me
I make you happy
Do not worry Be Happy
I’m out of cash, I’m out of style
I ain’t got no girl to make you smile
but don’t worry be happy
Cause when you worry
your face will frown
And that will bring everyone down
So don’t worry, be happy (now)…..
There’s this little song I wrote
I hope you learn it note for note.
like good little kids
Do not worry Be Happy
Listen to what I say
In your life expect some problem
But when you worry
you do it twice
Do not worry Be Happy……
don’t worry don’t do it be happy
put a smile on your face
Don’t bring everyone down like that
Don’t worry, it will pass soon
whatever it is
Do not worry Be Happy”
The bottom line: “Notice” shouldn’t be a problem in most receivables financing situations; Unannounced factoring is another option that is available to businesses concerned about confidentiality that meet minimum credit standards for asset-based loans. Bobby McFerrin was right: “Don’t worry, be happy.”
Copyright © 2007 Gregg Financial Services