For some companies, filing for Chapter 11 protection is an easy way out.  For others it is a necessity.  Either way, filing a Chapter 11 is an expensive proposition—in a number of ways.

The expense of filing a business bankruptcy, especially for bigger companies, is sometimes a dollar and cents decision, since the larger the company the greater the professional fees, on a percentage-of-assets basis, the estate will incur.

Overall bankruptcy and other professional fees can amount to tens of billions of dollars a year for U.S. companies. Often the amount billed is based, not only on the duration of the case and the company’s assets but the location of the filing and the number of professional firms approved, by the court, to apply for fees. 

Often creditors ask, how can some professionals justify high rates?  Such professionals  argue in favor of such rates, stating they increase the value of the company, which in turn increases the amount of money available to pay creditors. Right or wrong, high professional expenses are one of the major variables to consider before filing a bankruptcy petition.

Also, before deciding to file for bankruptcy consider the possibility of management losing control of the company.  Trustees, creditors, shareholders and others often end up overseeing the operations of company once it files its petition.

Finally, another fact to consider is that a Chapter 11 proceeding is seldom a quick process.  Often, the path to emerging from reorganization is a lot longer than management anticipates.

The term “Factoring” has gotten a bad reputation in the world of small business credit over the years. The question is why does the oldest form of financing conjure up such disdain? Maybe because factoring is misunderstood. Let’s try to set the record straight and educate business owners why factoring is a great solution to their cash flow problems.

Many small business owners view factoring as financing of a “last resort” and worry about what their employees or customers will think about the longevity of the business once they learn their employer/supplier has entered into such a financing arrangement.

While business owners should be concerned about how their customers perceive their business, entering into a factoring arrangement is rarely the “red flag” many fear it will be due to the fact factoring has become a much more common means of providing a company with access to working capital.  The odds are excellent many of your customers are already familiar with factors as so many suppliers are taking advantage of this valuable financing tool.

Since access to business credit has obviously contracted over the last few years, it has become more challenging for small businesses to obtain business credit lines.  Many lenders reserve secured or unsecured business lines of credit for only their “best” customers, which are often defined as those who have strong profits, increasing revenue trends and high balances on deposit.

Factoring can be a convenient alternative to businesses which cannot meet today’s stringent criteria for small business loans but have a strong base of customers.  Under most factoring arrangements, the factoring company ignores the financial condition of the client and strictly focuses on the credit quality of their customers.

If the customers are creditworthy, there is an excellent chance a factor will be interested in “factoring” the accounts receivable.  When factoring a receivable, a business sells or assigns the right to be paid by their customer to the factoring company in order to receive the bulk of the amount due (usually 85-75%) shortly after issuing the invoice, with the balance, less a factoring fee, remitted to the business once their customer makes payment to the factoring company.

Fees can range from 2% – 5% of the invoice amount for each 30 days an invoice is outstanding.  In other words, if a customer typically pays their invoices in about 40 days, the business would take on average about a 3% discount on their invoices in exchange for the factoring company advancing 85-75% of the invoice amount shortly after it is issued.

Like any industry, there are also unscrupulous factoring companies out there.  It is important to ask for references and to Google the name of the factoring company you select to see what, if any, complaints are out there.  Many factoring companies are run by long-time veterans of the business and are often the best choice with which to develop a financing relationship.

Stop thinking about factoring as a dirty word and instead think of factoring as the working capital bridge needed until you can meet the standards for traditional business credit lines.

There are lots of factoring companies out there but how do you pick the right one.  First it is important to understand why you might factor. Factoring allows companies to collapse the cycle between shipping products and receiving payments by advancing 70% to 90% against a customer invoice immediately. Most factors can fund the same day an invoice is valid and most within days. Thus, a factor can help you speed up the conversion of cash tied up in accounts receivables.

Here are some guidelines for picking a reputable factor and also a factor that is a good fit for your business.

Knowledge of the client’s market.  Does the factor understand your business and industry? Have they worked with some of your clients? As a test, ask the prospective factor to assess the creditworthiness of your top accounts.  Did the prospective factor give adequate credit limits for you clients? If the credit limits are too low, then you won’t be able to factor as much as you planned and this factor may not be the right choice. You want to make sure the factor can grow your credit limits as you grow sales. Otherwise, why factor.

Cost of money and fees.  Different factors have different pricing models and will price the same deal drastically different. You need to understand what you will actually pay for factoring. If a factor’s pricing model is complex and seems to have a lot of variables, chances are you will pay more than you think. Go with a factor with an easy to understand pricing model. The easier it is to understand a pricing model the better you can manage the cost. Beware of low “tickler” rates which sound great but will usually have a ton of buried costs.

Buried costs. Make sure you're clear on the factors' agreement and what the actual fees will be. Go thorough lots of examples with the factor so you understand when possible extra costs will be charged.  For example, does the factor charge any administrative fees, termination fees, minimum use fees, or document fees? Most companies don’t take the time to read the legal documents and are later shocked at all the fees they are paying. Do your homework and ask a ton of questions.

Multiple references. Ask the prospective factor for references. You should get references for past and current clients of the factor. This will give you a chance to find out how the factor has handled other clients and will allow you to get a real idea of who you will be doing business with. If the factor won’t provide client references, then this is not a factor for your company!

It's all about credit risk. If you sell on open credit to your customers, there will be times when you are concerned about repayment. The first question you should ask yourself is: Why would I sell on open credit to a questionable credit risk? The second is: Is it worth it?

It you are funded by a recourse factor, you retain the credit risk of non-payment. In the event your customer goes bust or just doesn't pay, you are ultimately responsible for any funds advanced to you by the factoring company. How can you protect your company against a bad credit?

One option is trade credit insurance which insures manufacturers, traders and providers of services against the risk that their buyer does not pay (after bankruptcy or insolvency) or pays very late. The trade credit insurance premium will be based primarily on the credit profile of the customers you are insuring against. The trade credit insurance policy will pay out a percentage of the outstanding debt. This percentage usually ranges from 75% to 95% of the invoice amount, but may be higher or lower depending on the type of cover that was purchased.

What kind of risks are insured? Trade credit insurance insures against the risk that a buyer does not pay. It can also cover the risk that a buyer pays very late. A buyer will not pay after he has been declared bankrupt, insolvent, or a similar legal status. Similarly buyers sometimes opt for a bankruptcy protection arrangement, which allows them to delay payments for an extended period. Both instances are covered under a trade credit insurance policy. Trade credit insurance policies can include a wider range of cover, depending on the circumstances. Some policies consider a delay in payment also to be an insolvency (so-called protracted default cover).  If a buyer does not pay, the trade credit insurance policy will pay out a percentage of the outstanding debt. This percentage usually ranges from 75% to 95% of the invoice amount, but may be higher or lower depending on the type of cover that was purchased.

Thus, if you are factoring with recourse and you don’t want to be on the hook for all the credit risk, trade credit insurance may be an option.

Recourse factoring
In recourse factoring, the factor does not take on the risk of bad debts. Put another way, the factor will be able to reclaim their money from you if the customer does not pay. The factoring agreement will specify how many days after the due date for payment you must refund the advance. Whether you refund the advance or not, you will still have to pay the fee and interest.

Recourse factoring is cheaper than non-recourse factoring and may have fewer requirements concerning your customers and your systems. This is because you (the client) are taking the bad debt risk. For example: 

• The factoring agreement requires payment to be made within no more than 90 days from the invoice date. It also states that 80 per cent of each invoice will be advanced.
• On 30 April an invoice for $10,000 is submitted for funding and the factor advances $8,000.
• On 31 July, if the customer has not paid the invoice so the advance of $8,000 must be repaid to the factor. There is no refund of the factoring fees relating to the debt.

Non-recourse factoring
In non-recourse factoring, the factor takes on the bad debt risk. The non-recourse factor accepts specified risks around the debtor's failure to pay, but it does not insure against debts that are unpaid because of genuine disputes. Because of this, non-recourse factoring is much more expensive than recourse factoring.

You never have to refund the advance to the factor, but you must pay interest to the factor for any advance against the invoice for the period prior to the bad debt payment being made.
The factor takes over all rights to pursue the customer for payment. This includes the right to take legal action.

Increasing sales doesn’t always equal increased cash flow, especially if the sales were credit sales. Thus, you can increase sales and accounts receivable but still have no cash in the bank account. Managing your cash flow effectively requires close attention, just like managing the rest of your business. The good news is that a little attention can go a long way towards increasing the cash balance at the bank. As with all good things, a little work is required so let’s look at how you can improve some of your operating processes which will increase CASH!

Here are a few tips that can have an almost immediate impact on your cash flow and cash position.

1) Set a price and term policy, then stick to it - You need to make sure all your employees understand the importance of discussing pricing and payment terms during the sales process. Often the emphasis is placed on "getting the sale" not "getting paid." When customers delay payments, they're using your cash and costing you money. Basically, you are financing their business. Be diligent about setting payment expectations right from the beginning with your customers.

2) Send out invoices in a timely manner AND follow-up promptly - The quicker you send out the invoice, the sooner the clock starts ticking for a customer to pay. Send out invoices promptly and follow-up immediately with a courtesy call. A courtesy call isn’t a collection call but a call just to check in with the customer and make sure the invoice has been received.

3) Review how your customers can pay you - Do you only accept checks?  Are you still living in the 80’s? Get with it and offer other options such as electronic transfer, wire payment or credit card. Make it easy for the customer to pay you.

4) What's in our inventory? - When was the last time you took a look at your inventory? Are you still selling Sony Walkmans? The 80/20 rule applies to inventory - 20% of that inventory is turning while 80% sits idle, taking up space and costing money to finance. Consider running a clearance sale or re-merchandising product to free up this cash.

5) Ask your vendors and suppliers for a discount! - When you purchase goods or services always ask if there is a discount offered for paying early or with cash. A 5% discount for paying now versus in 30 days is like getting a 60% discount on an annual basis. Don't be afraid to ask, the worst they can say is "no."

6) Customer deposits - If you're offering aggressive pricing or giving concessions, don’t be afraid to ask for something in return. This is a great time to ask your customer to pay a deposit at the time of order, or prior to starting a job. This helps cover your up-front costs, and the risk associated with non-payment is decreased when your customer has some investment in the transaction.

7) Require a minimum order for credit sales - Invoicing, collecting, receiving and depositing checks is a time-consuming and expensive process. Establishing a minimum credit purchase requirement eliminates having to chase small amounts, promotes larger orders and collects payment for smaller ones at time of sales. A smart business move!

Cash flow is the life's blood of your business. You can sell a million widgets but if you only get paid for 50% of them, your business is destined to fail. Making changes to your operating processes to promote positive cash flow is a way to keep your business healthy, vibrant and able to meet its obligations.