Some companies ask their vendors to provide net-90 days or longer to pay invoices. This request often strains the vendor’s cash flow. Few companies can wait three months to get paid. Vendors often address this challenge by trying to finance these invoices. Unfortunately, most net-90 invoices cannot be financed with factoring. This article explains why these invoices cannot be financed and discusses one possible exception. We cover:
- Credit insurance issues
- Problems with lending covenants
- Is your customer financially healthy?
- Can your company afford the cost?
- Which net-90 invoices can be financed?
1. The invoice cannot be credit insured
Many factoring companies use credit insurance on the invoices they finance for their clients. Credit insurance offers some protection to the factoring company if the end customer defaults. This type of insurance is essential for factors and helps them manage their bad debt.
The problem is that credit insurance companies won’t usually finance invoices with terms that extend beyond net-90. The reason for this refusal is that the risk of default increases the longer an invoice remains outstanding. Most credit insurance companies are unwilling to absorb this risk.
A factoring company that chooses to factor an invoice with terms beyond net-90 days must absorb the entire risk of default. This decision increases the finance company’s risk profile and is often not allowed by its primary lender’s covenants.
2. Problems with lending covenants
Most factoring companies use bank financing to fund part (or most) of their operations. Bank loans have conditions called covenants that the borrowers must comply with at all times. Banks usually include a covenant in the loan that prevents the factoring company from using bank funds to finance net-90 (or longer) invoices.
The factoring company has the option to finance these invoices using their retained earnings. Even if they use their retained earnings to finance the invoice, the factoring company must comply with other covenants, which include financial ratios. A net-90 transaction that defaults could cause the factoring company to fall out of covenants and put its lending facility at risk.
3. Is your customer financially healthy?
Companies ask for payment terms because it improves their cash flow. However, asking for excessively long terms can indicate cash flow problems. Most factoring companies prefer to avoid the risk and decline financing those invoices. There are financially healthy companies that demand net-90-day terms simply because it is to their advantage. Some of these invoices may be financed under the right circumstances. We discuss this scenario in the last section.
4. Can your company afford the cost?
Invoice factoring is more expensive than conventional financing solutions. The cost of factoring is based on the volume of receivables and how long they take to pay. Longer transactions are more expensive than shorter ones. Monthly rates can range from 1.5% to 3.5% based on the specific details of your transaction.
A factoring line works best if your accounts receivable turn in less than 60 days and your profit margins are above 20%. A company with large profit margins could potentially afford to factor invoices for 90 days. However, companies with low or moderate profit margins must weigh the costs and benefits of using factoring.
5. Which net-90 invoices can be financed?
Some factoring companies can make exceptions and factor invoices over net-90 days if the transaction is financially justified. However, only a few factoring companies will consider these types of transactions.
Let’s examine the transaction from the finance company’s point of view. The factor must be willing to finance the invoices without credit insurance while using only its capital. It must also risk falling out of covenant if the transaction is large enough and defaults. This type of transaction has a high risk.
Your chances of success improve if your customer is a large, financially healthy company. These companies are usually well-established, have high brand recognition, and have a long track record of success. Examples of these businesses include companies in the Fortune 500.
Additionally, your profit margins need to be high enough to support this transaction. There is no set profit margin since the specific transaction details determine the requirements. However, a profit margin of 50% (or more) could work if everything else checks out.
Get more information
We are a leading factoring company and can provide you with a competitive factoring quote with high advances and low rates. For more information, call us toll-free at (877) 300 3258.