Factoring in Canada

Factoring is a form of business financing that has been gaining popularity in Canada. It helps companies with cash flow problems because their clients pay their invoices in 30 to 60 days. This article explains how factoring works and covers:

  1. How does factoring work?
  2. The role of factoring
  3. What are the benefits?
  4. How much does it cost?
  5. Who is a good candidate for factoring?
  6. Differences by province

1. How does factoring work?

Factoring provides you with working capital by financing your invoices from slow-paying clients. In most transactions, invoices are financed in two instalments.

The first instalment is commonly referred to as the advance. It is provided soon after you submit the invoice for financing. It covers 70% to 90% of the gross value of the invoice. Note that the percentage varies by industry.

The second instalment covers the remaining funds that were not advanced. It is deposited to your account once your customer pays the invoice in full. The finance fee is usually deducted from the rebate.

Most clients use invoice factoring on an ongoing basis because it provides them with predictable working capital. They can use the increased stability and working capital to focus on growing the business. For more information, read “What is Factoring?” and “How Does Factoring Work?

2. The role of factoring in financing

Getting financing has always been challenging for small companies. Institutions and lenders have consistently focused their financing efforts on larger companies that are doing well. This approach is sensible, given most lenders’ size and risk parameters.

Unfortunately, this situation leaves many small and midsized companies with limited alternatives. These companies include single-person businesses, growing businesses, and companies undergoing a turnaround.

Factoring fills the gap in the financing market and provides financing to companies that cannot get conventional funding. When used correctly, factoring can help a company grow and can be a stepping stone to eventually getting conventional financing.

3. What are the benefits of factoring?

Factoring provides a number of benefits to companies. Some of the more important benefits include the following:

a) Provides immediate working capital

The main reason companies use factoring is that it improves their cash flow quickly. Factoring gives them the funds to pay expenses and grow.

b) Enables you to offer net-30-day terms

Factoring allows companies to offer their customers net-30-day terms while minimizing cash flow concerns. This flexibility helps companies expand their customer base.

c) The line is adaptive

The line is adaptive and can grow as your company’s accounts receivable grow. Major line increases can usually be approved quickly as long as they are backed by quality accounts receivable.

d) Available to small businesses

Factoring can be used by companies of any size. This includes single-employee businesses and small companies.

e) Easier to obtain than alternatives

Getting a factoring line is easier than getting conventional financing. Most factoring companies have simple qualification requirements.

f) Can be set up quickly

Lines can be set up in a few days if business owners provide the needed information quickly and if invoices can be verified in a timely manner. This fast turnaround makes factoring a viable alternative for companies that need working capital quickly.

4. How much does it cost?

The cost of factoring is based on the size of your accounts receivable, your industry risk, and your company’s risk. Most factoring companies charge a rate of 1.5% to 4.5% per 30 days, depending on these parameters. Rates are usually prorated to account for longer or shorter time periods.

5. Who is a good candidate for factoring?

Factoring is specifically designed to help companies that have cash flow problems due to slow-paying A/R. For more information, read “Is Factoring Right for My Company?” Factoring works best for companies that meet the following criteria:

a) Have creditworthy commercial clients

Factoring companies provide financing based on the quality of your invoices. Consequently, your customers must have good commercial credit. Factors can determine credit through service bureaus such as Dun and Bradstreet.

b) Companies pay you on net-30 to net-60 days

Your invoices must be for delivered products/services, and your clients must pay in 30 to 60 days. Factoring may be used for invoices that take longer to pay only if your profit margins are high.

c) Your cash flow problems are due to slow A/R

This solution only helps companies with problems that stem from slow-paying accounts receivable. Unfortunately, factoring is not the right solution to help with other types of cash flow problems (e.g., profitability issues, etc.)

d) Your company has adequate profit margins

Factoring is more expensive than other financing solutions, so it’s important that companies have adequate profit margins. Ideally, the profit margin should be over 20%, though higher is better.

e) Accounts receivable cannot be encumbered

Your accounts receivable must be free of liens. Note that if your company has existing financing, it’s likely that the lender holds a lien against your A/R.

f) Your company has no serious legal/tax problems

Accounts receivable factoring can be used in turnaround situations and for companies with problems. However, the company cannot be at risk of bankruptcy or have serious tax issues.

6. Differences by province

Invoice factoring is used in a number of industries across Canada and is available in all provinces. However, there are some regional variations that businesses should be aware of.

a) Industry specialization

Most factors can work with companies in most industries that invoice commercial clients on net payment terms. However, some companies develop a specialization to cater to their local industries. In general, companies are better off working with a finance company that has direct experience in their industry. For example, factors with a presence in Alberta or Saskatchewan may have a strong concentration in the oil and gas industry. On the other hand, factoring companies based in Ontario may have a concentration in the business services industry.

b) PPSA vs hypothèque

Factoring companies can finance invoices only if they can secure their position against your accounts receivable. In most provinces, this requires a PPSA. The process is slightly different in Quebec, which uses hypothèques. Companies based in Quebec may be better off working with a factor that has experience working with clients in the province.

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