Cash flow software with factoring receivables (How factoring affects cash)

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The all important what-if scenario of introducing factoring receivables to cash flows

One of the easiest solutions for an immediate cash injection to your business is to factor your receivables. But how will this affect the profitability of your business and how much will it benefit your cash flows? You may like to review the what-if scenarios before you commit. So does the cash flow software have factoring receivables built-in? Let’s take a look…

Cash flow software with factoring receivables in 15 seconds…

Factoring receivables helps businesses to bridge the gap between the timing of the incoming receipt of payment from customers to the timing of the outgoing payment of operational costs and expenses. But to plan for the switch to debt factoring you need to prepare cash flow forecasts beforehand. To do so you need cash flow software with factoring receivables built-in. Or alternatively, you need to be able to create complicated spreadsheets to prepare your own cash flow forecasts.

Cash flow software with factoring receivables

The most obvious software to look at cash flows when you’re looking into factoring your business’s receivables is spreadsheet software. Finance departments and accountants around the world always jump to Excel or similar software when they look at cash flows, They are comfortable with creating complicated spreadsheets and doing what-if scenarios with various difficult formulas.

But what if you’re not comfortable with or experienced at using spreadsheet software? What if you’re not too sure how to work-out complicated formulas? Or alternatively, what if you don’t have the time to sit and spend your day (or days) creating the various worksheets to produce the reports needed to evaluate the impact of factoring your businesses receivables.

What then? But before answering this question, what is factoring of receivables?

What is factoring of receivables?

Factoring of receivables or debtor finance is when a business sells its accounts receivable (i.e., invoices) to a third party. This third party is called a factor company and is often a financial transaction offered by most commercial banks.

Invoices are sold at a discount or subject to a factoring fee

The invoices are ‘sold’ at a discount or subject to a factoring fee. The level of discount or factoring fee is partly dependent on the factor company’s assessment of business risk and of the sector the business operates. This is usually anything up to 5% of the invoice value.

Also, the amount advanced to the business by the factor company will not be the full face value of the invoice, but instead a reserve account will be created. This reserve is set at somewhere between 10-20% of the invoices. However, what this does mean is that the business will benefit from an immediate cash receipt of between 80-90% of invoices raised.

Amounts advanced from factoring companies are charge to interest

In addition to a factoring fee, the factoring company will charge your business interest on amounts advanced. The interest charged will depend on the factoring company and the risk score of your business and the receivables being factored.

Not all sales can be factored

One further point is that not all sales can or need to be factored. Factoring companies may exclude certain businesses or customers from the advance percentage. This could mean for example that of the sales generated you can only factor say 90%.

An example of where this would apply is that factoring companies will not factor individuals and will only factor commercial debt. So where your business is a mixed B to B & C, it is only the B to B sales that can be factored.

Businesses factor their receivables to meet current cash flow and working capital needs.

Is factoring receivables a good idea?

Factoring receivables are an excellent solution for businesses that are growing and require more working capital. This is especially true of businesses which have long net terms. Which means the business provides long term credit or payment terms to its customers.

Where factoring receivables works particularly well is for businesses with long customer credit terms, but that also where the business has high ongoing operational expenses. This includes high cost of sales or employment costs, which are likely to need paying before the receipt of cash from customers. It is this cash-vacuum that is filled with the cash advance from the factoring company.

Factoring receivables helps businesses to bridge the gap between the timing of the incoming receipt of payment from customers to the timing of the outgoing payment of operational costs and expenses.

Many small businesses seek factoring finance when they experience cash flow shortages due to a slow turnover in accounts receivable.

But it’s worth pointing out that factoring receivables isn’t cheap. You need to plan and prepare your cash and profit forecasts to see if it’s worth doing.

How do you account for factored accounts receivable in a cash flow forecast?

Preparing cash flow forecasts are not always easy at the best of times. But when you introduce factored receivables into the mix, this will cause most people to run a mile if they have to prepare a spreadsheet for this. It does cause most people a headache or two, which includes those accountants among us!

So how do you account for factored accounts receivable in a cash flow forecast?

Assumptions used to demonstrate how to include factoring receivables into your cash flow forecasts:

  1. Factored receivable (total sales): $100,000.
  2. Advance rate: 85% (Which means the reserve is set t 15%).
  3. Factor company fees 2.5% ($2,500).
  4. In this example, VAT or sales tax is ignored.
  5. In this example, it is also assumed that 100% of the sales are factored.

The following steps need to be included in your cash flow forecasts:

  1. Month in which cash is advanced from factor company: Cash is increased by $85,000. (Double entry journal: Dr Cash $85,000; Cr Amounts owed to Factor company $85,000).
  2. Month in which the factor company charge their factoring fee or discount: Cash is reduced by $2,500. (Double entry journal: Dr Factoring fees $2,500; Cr Cash $2,500).
  3. Month in which the invoice is paid by the customer (i.e. assuming payment in full of $100,000): Cash is increased by $15,000. (Double entry journal: Dr Cash $15,000; Dr Amounts owed to Factoring company $85000; Cr Trade debtors $100,000).
  4. Month in which the factor company charge their factoring fee or discount: Cash is reduced by $2,500. (Double entry journal: Dr Factoring fees $2,500; Cr Cash $2,500).

The following steps need to be included in your profit forecasts:

  1. Month in which the sale is made and the invoice is raised: Sales are increased by $100,000. (Double entry journal: Dr Trade debtors $100,000; Cr Sales $100,000).
  2. Month in which the factor company charge their factoring fee or discount: Factoring fees in overheads is increased by $2,500. (Double entry journal: Dr Factoring fees $2,500; Cr Cash $2,500).

The following steps need to be included in your projected balance sheet:

  1. Month in which the sale is made and the invoice is raised: Trade debtors on the balance sheet are increased by $100,000. (Double entry journal: Dr Trade debtors $100,000; Cr Sales $100,000).
  2. Month in which cash is advanced from factor company: Cash on the balance sheet is increased by $85,000 and amounts owed to factor company are increased by $85,000. (Double entry journal: Dr Cash $85,000; Cr Amounts owed to Factor company $85,000).
  3. Month in which the factor company charge their factoring fee or discount: Cash on the balance sheet is reduced by $2,500. (Double entry journal: Dr Factoring fees $2,500; Cr Cash $2,500).
  4. Month in which the invoice is paid by the customer (i.e. assuming payment in full of $100,000): Cash on the balance sheet is increased by $15,000, amounts owed to the factoring company is reduced by $85,000 and trade debtors is reduced by $100,000. (Double entry journal: Dr Cash $15,000; Dr Amounts owed to Factoring company $85000; Cr Trade debtors $100,000).

How can factoring receivables increase cash flow?

If you’re not too familiar with what factoring receivables works, let’s take a look. If we base my answer on the above example of how you account for factored accounts receivable in a cash flow forecast.

Let’s assume this example business offers 90-day credit terms to it’s customers. But also, let’s assume the total direct costs and overheads represent 80% of the sales. But that on average, these direct costs and overheads have an average credit term of 30-days.

Before factoring receivables is introduced, by the end of month two the business will need to find cash to the turn of $80,000 from somewhere. If the business already has $80,000 as working capital, this isn’t a problem. However, if it doesn’t it will need to find $80,000, which is where factoring receivables comes in.

After the business factors its receivables, by the end of month one there will be $85,000 in the bank. This is more than sufficient to cover the $80,000 direct costs and overheads due by month two.

However, the cost to this business of factoring its receivables is 2.5% of sales. Which will reduce profit from $20,000 before factoring receivables was introduced to $17,500 afterwards.

What you have to do as a business owner is to weigh up this cost vs reward to cash flow argument. But before you do so, it’s a good idea to run the cash flows and profit forecasts for your business to see if it’s worth it in the long run.

With that in mind, let’s now look at cash flow software with factoring receivables built-in.

Cash flow software with factoring receivables built-in – The alternative to creating your own complicated spreadsheets

The alternative is to use cash flow software with factoring receivables already built-in. However, most software that has this already built in is either complicated to use or very expensive.

If you’ve searched for cash flow software with factoring receivables built-in because you need to buy this as you either don’t have the time to create the necessary spreadsheets. Or if you don’t have the knowledge or expertise to do so, then please take a look at our Cash Forecaster Software.

With Cash Forecaster you have all the complicated calculations done for you. Therefore, the following entries are made easy:

  • All of the entries in the example above are calculated automatically.
  • You simply enter the percentage of sales that can be factored.
  • Enter your customer payment terms.
  • Enter the advance percentage of the factoring company.
  • Set the various factoring charges and rates, which includes: Factoring fee or discount; interest rate; whether the fees are subject to sales tax or VAT; Month in which factoring begins in your cash flow forecast period; Month in which factoring ends, if you choose to withdraw from factoring.
  • Enter your sales forecast for the period of either 12 months, through to 7 years.
  • Reports produced include among others; cash flow forecast, profit forecast and projected balance sheet.

Of course your cash flow and profit forecasts aren’t only about the sales forecast. This should also include your cost of sales or direct costs and overheads. But it will also include capital expenditure over the forecast period too. All of this is included in Cash Forecaster Software too.

What are the benefits to factoring receivables?

In addition to improving cash flow, what are the other benefits to a business or introducing factoring receivables? This include:

  • The factoring company will credit check customers to further protect the business from bad debt.
  • The factor company will help you to set credit limits for customers where necessary.
  • Some factoring companies offer debt insurance to cover for bad debts. But this can be quite costly and they will only offer insurance cover on certain customers and usually only if they pass the credit referencing.
  • They also offer and optional complete account receivables management service, which would include debt monitoring and collection services.
  • This form of debt is a benefit to businesses which don’t have other assets to secure lending on, like service businesses.
  • Unlike bank loans, factoring lending decisions are based on the quality of receivables rather than the corporate credit score, financial ratios and historical financial performance.
  • Factoring receivables offers a great solution for companies at risk of over-trading, as factoring provides liquidity which grows directly with sales.

I hope you enjoyed this article about cash flow software with factoring receivables

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