SFG's Cash Flow Industry Blog

This article will suggest the most creative way to buy real estate with discounted notes. It is a wonderfully intriguing method. Even if you cannot do this exactly, you will still have the very real possibility of trading notes you bought at a discount for full face value on a piece of property. These ideas come from such innovators as Joe Land, Pete Fortunato, and others.

The scenario

First, consider that there is a $160,000 duplex for sale with a $40,000 first trust deed on it. The owner of the property, Sally Seller sells the duplex to Paul Payor. Paul puts down $40,000 cash, he assumes the $40,000 first mortgage, and Sally agrees to carry back an $80,000, 30-year second mortgage. She is happy with the extra income from the second mortgage, and the $40,000 cash down payment.

Second, consider the older, conservative home owner who owns his home free and clear, Harry Homeowner. He decides to sell the home. He does not need all the cash but would like to have a steady income for retirement. Their home is worth $100,000., so Harry and his wife advertise that they will sell their home with a 20% cash down payment, and they are willing to carry an $80,000 first mortgage.

Third, reconsider Sally Seller who has been receiving payments on her $80,000 note. She is offered a chance to buy a share in a restaurant with a friend. She is excited about the opportunity, but has spent all of her money including the down payment she received. She is not able to borrow the cash to invest.

The only asset she owns is the $80,000 note. She calls you, Ned Notebuyer (or Nancy Notebuyer). You offer Sally Seller $48,000 for her long-term $80,000 note, which she gladly accepts after you skillfully explain to her the discount she must take on this very long-term note.

Buy a $100,000 house for $68,000

Think for a moment about this situation. You have Harry Homeowner who wants an $80,000 note and Sally Seller who wants to sell her $80,000 note. The only person missing from the picture is you, Ned (or Nancy) Notebuyer!

Your obvious solution to helping the two parties is, perhaps, shortsighted. You are saying, "Great, I will buy the note from Sally Seller for $48,000 and trade it to Harry Homeowner for the full $80,000. If I give Harry Homeowner $20,000 cash down, and he agrees to accept Sally's note, I will have bought a $100,000 house for $68,000." ($20,000 down plus $48,000 for Sally's note.)

"Terrific," you say, "but this costs a lot of money". You would need $68,000 in cash. Can you think of a way to consummate this transaction with no cash?

Make a great deal even better

First, you must convince Harry Homeowner to take back a note on a property other than his own. He was expecting to have a mortgage on his own home. But you can point out to him that by taking the second mortgage on the duplex he has more equity protection and a seasoned note.

He has no idea how you, the new buyer, will perform on the loan. But Sally Seller's loan is several years old and is well seasoned with a good payor. After seeing Paul Payor's credit report and his payment record, Harry agrees to accept Sally's note from you. If Harry is willing to sell you his house and accept Sally's note, then his house if free and clear.

If you are buying Harry's house, and it is free and clear, you can get new financing! You go to the bank, and the bank says they will loan you $80,000 if you will make a $20,000 payment. You say okay, and perhaps show the note as your down payment.

I'll take the leftovers, please

All parties agree to the deal, and you go to escrow to close the purchase of Sally's note, and the purchase of Harry Homeowner's house. The bank has given the escrow officer a check for $80,000 secured by the house you are purchasing from Harry. The escrow officer writes a check for $48,000 to Sally Seller for her note.

The escrow officer then writes out a check for $20,000 to Harry Homeowner and gives him Sally's note. She transfers the house to you with the $80,000 mortgage on it. She writes out a check for $4,000 in closing costs to the bank. She then says to you: "Wait a minute, I still have $8,000 left! What should I do with that?" You raise your hand and say, "I'll take it!"

You have picked a home with $20,000 equity, you have $8,000 in cash, and you have spent none of your own money! The lesson is that real estate notes bought at discount can trade at full face value in the real estate market. Great profits can be made if you learn this lesson.

About the author...

Jon Richards was the founder of NoteWorthy Newsletter, the major newsletter for buyers and brokers of cash flows on the secondary market. It has been published monthly since October 1989 and is the largest paid subscription newsletter in the industry. Jon was the publisher of the NoteWorthy Newsletter until his death in 2003.

Factoring is a better way to obtain money quickly for your industry. No matter what you business or industry, we can help you get on track financially. This page will help you to understand the terms used in factoring. However, it’s not necessary that you understand all of the terms – just call us and we’ll help get you started.

Account Debtor - The customer of a factor's client. The company owing the money due on the invoices. Also known as the customer.

Accounts Receivable - Trade credits; an amount owed by an account debtor by the act of granting short term unsecured credit in lieu of cash for goods or services. Considered a liquid asset on the balance sheet and generally expected to be paid in less than ninety days.

Accounts Receivable Financing - A short-term financing technique for working capital purposes, loans to a company are collateralized by a security interest in a company's account receivables. Account receivables serve as collateral, and loans are made on a percentage of eligible assets pledged.

Acquisition - A loan to assist in acquiring the assets of a business.

Asset Based - A business loan where the borrower pledges as collateral for the loan any assets used in the conduct of his or her business. Funds are used for business related expenses. All asset-based loans are secured.

Credit - A privilege granted for the purpose of extending time to make payment on a debt.

Customer - The client's customer. The company which pays the money due under the factored invoice. Also known as the account debtor.

Dilution - The amount of risk associated with collection of the accounts receivable. It can include returns, charge-backs, trade allowances, concentrations, slow pay, bad debt and other perceived risk.

Due Diligence - Background check and research conducted by the factor to assess validity of a prospective factoring client and that client's customers.

Factor - The funding source for the client. The company which purchases the accounts receivable (invoices) from the client.||Factoring - The selling of a company's accounts receivable to a third party, in order to obtain funding.

Factors Acknowledgment Form - A form sent to the client's customer by the factor, confirming that the client's invoice does exist and that the customer will remit the payment due under that invoice to the factor.

Factors Advance - The money the factor sends to the client up front, after the verification process is complete, and before the factor receives its money from the client's customer. The advance is figured as a percentage of the face value of the factored invoices.

Factors Charge-Back - An amount of money that is owed to the factor and is deducted or Charged-Back from the reserve or availability of the line due to an agreed upon non-payment by debtor clause in the Factors contract.

Factors Client - The business which sells its accounts receivable to the factor.

Factors Fee - The fee the Factor Charges for funding the clients A/R.

Factors Reserve - A deposit maintained by the factor, to guard against disputes between the client and the customer, and to guard against bad debt losses due to customer non-payment. This is the money retained by the factor when the advance is sent to the client. The Reserve is sent to the client after the customer has paid the factor the money due on the invoice.

Factors Reserve Release - The amount of money released from the Factors Reserve once payment has been received and credited. The Reserve Release may be less any charge-back or fees associated with the services.

Factors Services - Credit Analysis, Credit Guarantees and Collection Management.

Factors Verification - Process by which the factor verifies that the product or service provided by the client was received and accepted by the customer, and that the customer intends to pay the factor the money due under the invoice. This process takes place before the factor sends the advance to the client.

Recourse - In this type of factoring, the risk of customer non-payment remains with the client. If the client's customer is financially unable to pay the money due under the invoice, the factor has recourse against the client for that money. The factor is protected against customer non-payment.

Working Capital - Loans for business expenses such as, advertising, wages, rents, and other operational costs. Often these loans are secured by tangible assets or, in the case of long-standing good credit, by the "full faith and credit" of the company.

Feel free to contact us anytime for a free no-risk consultation toll-free at (877) 836-4661.

For years now, U.S. companies have heard about the emerging global economy and the abundant opportunities abroad to increase sales, insulate themselves from business cycles, and build brand equity. But for a variety of reasons -- trade barriers, inexperience with international trade, and financial risk -- many business owners have elected to bypass global markets. Today, a conflux of competitive and regulatory forces are driving many businesses from the sidelines to the playing field. And international factoring -- the sale of accounts receivable to international finance companies with the resources, expertise, and local presence to actively manage trade risk -- is providing a solid platform for success.

Rethinking Global Trade

It's easy for business owners to view international trade as an insurmountable challenge because of the many business risks involved. In many countries, for example, accurate credit information on potential trading partners is difficult to obtain, and credit analysis is further complicated by differences in accounting standards and procedures. Foreign banking systems can present further impediments -- everything from forward and back valuing on payment instruments, to foreign exchange transaction exposure, to delays in clearing international funds. Further, traditional trade finance tools such as bank Letters of Credit (LCs) and credit insurance can be costly to use and difficult to manage. Most important, exporters must weigh carefully the financial risks of offering trading partners the open account terms they require -- especially in countries whose legal systems protect debtors from their creditors.

In today's environment, however, maintaining solely a domestic focus can be every bit as risky -- especially as competitors gain strength by tapping global markets. Consequently, in industries as diverse as high-tech and plastics, more and more companies are committing themselves to global trade and making it work. For example, U.S. electronic exports reached $135.4 billion in 1996, an 8 percent increase over the previous year, and more than double from 1990. The plastics industry is also evolving into a truly global business. Steady demand for American-made plastics products from established markets in Western Europe and Japan, and significant pockets of growth in developing Asian and South American countries, have produced a trade surplus of approximately $4 billion a year.

Much of this momentum stems from the ongoing efforts of organizations such as the U.S. Department of Commerce and the impact of trade agreements like NAFTA, opening new markets in Latin America, the Pacific Rim, and other regions. But there is clearly another force at work: the steady rise of international factoring as a financing strategy. According to Factors Chain International, a network of 100 independent factoring companies that serve approximately three dozen countries, factoring contributed $28 billion to U.S. international trade in 1996 -- an increase of 19 percent over 1995. Indeed, factoring is proving especially well-suited to small- and mid-sized companies that either lack the resources to manage the administration of their international accounts, or that prefer to outsource this function.

Weighing the Options

One of the first decisions companies face when contemplating global trade is how to address the attendant credit risks and administrative responsibilities involved. The three traditional payment practices -- cash in advance, bank LCs, and credit insurance -- are all effective, proven strategies for facilitating cross-border transactions. But each has significant limitations. The drawback to cash in advance is that customers accustomed to the flexibility and convenience of open account relationships will typically object to payment before delivery. Another well-established option, bank Lcs, are effective and relatively convenient for the seller, but they are growing unpopular with buyers because they place a significant administrative and financial burden on the buyer to open, maintain, and pay the expenses associated with the LC. LCs also limit the buyer's financial flexibility by tying up valuable credit lines that could be used for other purposes. Plus, confirmation is not available for all banks, and disputes can be difficult and costly to resolve. The third option, credit insurance, usually does not provide full coverage, and its deductible and/or co-insurance payments expose exporters to additional credit risk. Further, credit insurance provides limited collection support; it typically requires exporters to perform their own credit investigations, and it places the burden on exporters to prove their claims.

By combining the best features of LCs and credit insurance, international factoring has emerged as an attractive alternative because it addresses the needs of both exporters and their customers. When exporters sell their accounts receivable to international factors, they can strengthen their selling power and solidify their trading relationships by offering their customers the open account terms they prefer. Companies can also minimize the credit risk and eliminate much of the administrative burden of global trade, because the factor assumes the credit risk and handles difficult and time consuming processes such as credit investigations, collection of receivables, and remittance of the proceeds directly to the exporter.

Exporters are also drawn to factoring because they can select the specific financial products and services -- receivables management (including bookkeeping and collection), 100 percent credit protection, and receivables financing -- that best suit their export program and financial situation.

To facilitate collection and improve cash flow, exporters can also leverage the local presence and resources of factors to help them turn receivables faster, improve their cash flow cycle, and strengthen trade relationships by resolving billing and payment issues. Factors even offer additional back office services such as bookkeeping and receivables management reporting.

If credit risk is a significant issue, factors can analyze the credit-worthiness of potential trading partners and also protect exporters from credit losses by assuming the credit risk themselves and paying off any outstanding invoices at 100 percent (less commission and fees) after a designated time period. Both receivables management and Credit protection are fee-based services. Fees are generally expressed as a small percentage of the invoice amount, with that percentage varying based on sales volume, invoice amount, credit quality of customers, and frequency and destination of shipments.

If business cycles create unsteady cash flow, factors can offer financing services based on international accounts receivable. Factors advance funds at an agreed-upon percentage of an invoice the day the title to the goods is transferred. Interest is accrued as with any normal loan, and the factor reduces the loan balance as customer payments are received by the factor.

Favorable Pricing

Exporters might expect to pay a steep price for factoring services, but direct comparisons between credit insurance, LCs, and factoring reveal the economic advantages of factoring. The chart on the previous page details these costs using the hypothetical case of a manufacturer with yearly overseas sales of $10 million, who ships to 50 overseas buyers with an average order and invoice size of $75,000 and maximum payment terms of 90 days.

Total expenses only tell part of the story, however. Though credit insurance enables the exporter to extend open account terms to its customers, it offers exporters only 90 percent credit coverage. If a credit loss occurs, exporters can expect their total costs to rise significantly. With LCs, the cost of credit protection for the exporter is borne by the buyer, and the fee structure of LCs -- which involves separate charges for activities such as issuance, amendments, discrepancies, and cancellation -- makes total costs difficult to estimate. With factoring, however, the exporter is fully insulated from credit risk and can offer open account terms for approximately 10 percent less than the LC cost.

Success Stories

Conex Cable, Inc., a Dublin, Calif.-based manufacturer of aluminum-clad steel wire products, began operation as a joint-venture company. In 1995, Hitachi Cable Ltd. of Japan became a 100 percent owner of Conex Cable, Inc. Since then, the company has been expanding its range of production and products and the business has gradually taken on a more international flavor.

When Conex set its sights on Mexico following the passage of NAFRA, it tumed to an international factor to provide credit protection for an initial transaction that, when completed, will total an estimated $1.6 million. Conex's president, Akira Kaneko, was drawn to the factor in part because its affiliate office in Mexico City offered a valuable local presence. But he also embraced the program the factoring company proposed. "Our single biggest concern with international trade was credit protection. When we expressed our reservations about export credit insurance and the exposure to deductibles and co-payments we would face, the factor recommended a non-recourse, non-notification export factoring program that eliminated this exposure altogether," Kaneko remarked.

New Jersey-based ITP, a mid-sized manufacturer of zippered plastic bags used for packaging, has also taken full advantage of the broad services and comparatively low costs that factors can offer. "We sell to Belgium, Canada, Chile, Colombia, Finland, France, Holland, Israel, Italy, Spain, and Switzerland, among others," says Gina Peter, Assistant Credit Manager. "If we had to rely solely on Letters of Credit, work would be a nightmare. Instead, we sell our receivables to our factor, which in turn collects for us and then credits our account."

Peter also calls upon her factor to perform credit checks when she's establishing trading relationships with new customers. "It's difficult to get reliable bank information from some foreign customers," she explains. "Factoring has helped us tremendously and has even given us some extra interest income. And, although we don't borrow against our receivables, it gives us an extra measure of comfort and security to know that we could, if necessary."

A Foundation for Growth

At a time when new trade agreements are making global trade more attractive than ever before, international factoring offers small- and mid-sized companies a practical, cost-effective strategy for penetrating global markets. By giving exporters the protection they need, and by extending open credit terms to their customers, international factoring provides a solid foundation for profitable new trading relationships that keep businesses on track for greater growth.

Written by Kenley A. Tarter

If you haven't yet read the earlier article titled "Tips on Creating a Real Estate Note", you may want to do so (see May 25th, 2005). That article provides some background pertinent to this one, and can be found here.

Perhaps you've recently come across a great investment opportunity. Or, maybe you need some extra cash flow to pay down debt. Whatever the reason, you have heard that you can sell your real estate note (more often called a mortgage note), but you aren't quite sure how it works or how to ensure that you get a good deal.

In the previous article, we discussed how to structure a note to help you obtain the maximum value from it. Let's say that the note has now been completed, you have received at least one payment from the property buyer, and now you've called us about selling the note.

The first thing that most note sellers think about is selling the entire note. If that scenario fits your financial situation and the note is likely to fetch a high value, you may want to go down that path.

But wait, you should at least understand other options in order to choose the one that is the best fit. Sometimes, note sellers like the interest rate that they are receiving on the note, but just want to obtain some amount of cash now. Or, what can you do if your note doesn't meet some of the criteria needed to fetch a high value (i.e. good equity and strong buyer credit)? It is possible, and often to your advantage, to just sell some of the payments. This is called a partial, and it can often provide you with a much higher rate of return.

An example can help here. Assume that you sold a house for $120,000, the buyer gave you $20,000 as a down payment, and you have a $100,000 note at 7% for the next 15 years (180 months). You enjoy getting the income each month but need $30,000 for another investment or to pay off debt. We could give you that $30,000 in exchange for buying the next "x" number of payments, after which the note reverts back to you for the remainder of the term.

There are also other ways to structure the note to meet your needs, such as getting a lump sum of money now plus receiving a part of the payment each month thereafter. A knowledgeable note buyer will be able to explain these to you in more detail.

The items that are described above and in the previous article apply mainly to 1st liens. If you have a 2nd lien, where there is a bank or another investor with a more senior lien against the property, you may be able to sell the note, but the price that you receive won't be nearly as high. You generally won't be able to sell those types of notes at any sort of decent price unless the buyer has put in at least 30% of his own money as a down payment or in built-up equity.

So, now you've received quotes for a full buyout of the note and a partial purchase, and have selected the one that best fits your needs. Since the note purchasing business is lightly regulated, you do need to be careful to work with a reputable investor or broker. Here are some things of which to be aware:

- Make sure that there are no upfront fees. A good note buyer isn't going to charge you just to provide quotes or check the buyer's credit.

- There should be no points, closing costs, or other garbage fees at any point in the process. Any fees are already included in the pay price to you.

- It is normal for the note buyer to require that you pay for the appraisal or the title policy ONLY if the property appraises for less than the sales price or there are problems with the title that prevent the purchase. However, these payments should cover just the buyer's actual costs.

- Ensure that the seller gives you a written purchase agreement covering the purchase price, contingencies, etc., and be certain to ask questions about anything that is not clear.

- Be certain that the note investor checks the credit of your property buyer upfront. There have been cases of unscrupulous buyers quoting one price and then lowering it toward the end of the process, often using the excuse that the "property buyer's credit was low". This "bait and switch" method is definitely not ethical.

So, what are the steps involved in selling your note? The process is simple and straightforward:

- Contact us and provide basic information about the note and property (type of property, sale price, payment amounts, etc.).

- We respond within one business day with your quotes.

- If you approve the quote, we ask you to send copies of the Deed of Trust or Mortgage, the Note, Title Policy, and Closing/Settlement Statement in order to check the buyer's credit and conduct our due diligence. If there is no recent appraisal or title policy, we arrange for those, at our expense.

- From the time that you approve the quote and provide the documents, it generally takes 2-3 weeks for you to get your money. You can choose to receive the cash via check or electronically.

Article written by Alan Noblitt of Seascape Capital Inc.

Over the past few years of low interest rates in real estate, there was not a lot of news about owner financing. Banks and credit unions have scrambled to find more customers by lowering their lending criteria and competing on rates, so that nearly anyone could find a loan for their house or business somewhere. That is still somewhat the case today, though it will become less so as interest rates continue to rise and foreclosures climb.

Even in these times, there are still a lot of sellers offering owner financing on properties. The reasons for offering owner financing vary, but include:

- Seller wanting to defer taxes on gains.
- Saving the high bank closing costs and fees.
- Creating more flexible terms and payment schedules.
- Weak buyer credit.
- Sales between family members, or divorce agreements.

Owner financing notes can vary, but always includes an agreed upon term, interest rate, payment amount, and payment date on which the buyer of the property must pay the seller. The conditions are formally written in a note, sometimes also called a promissory note or installment note.

Usually, the seller would have preferred to have received all of the cash upfront. Even if that wasn't the case at the beginning, circumstances may have changed or new investment opportunities have appeared that cause the seller to need cash quickly.

There are investors, both institutions and private, who will buy these notes. They will generally discount the note (pay the seller an amount below the note's current balance) to offset their risk and meet certain yield requirements. The amount of discount varies across notes, but the two biggest factors in determining the discount (besides the type of property) are the amount of equity in the property (cash down payment plus principal payments received) and the credit of the buyer. The more equity and the better the buyer credit, the more that the note is worth.

So, if you're creating a note, here are some tips to maximize the amount that you would receive if you later need to sell it, as well as help protect yourself if you don't:

- Obtain a good down payment. This means at least 10% for a standard house, and 20-30% for commercial properties, land, and mobile homes. These numbers cannot always be reached, so try to get as much as you can without putting the buyer into a financially precarious position.

- If you can, sell to a buyer with decent credit. A FICO (credit score) of at least 650 is preferable, though 625 is usually adequate. You'll often still be able to sell the note even if the buyer's credit is below 600, but be prepared to take a larger discount. Also, recognize that the FICO score does not always represent the buyer's ability and propensity to make timely payments, as they may have a low score due to having a lot of open credit but still be current on all payments.

- Ensure that the interest rate being charged is at least as high as comparable bank rates.
- Keep the term of the note as short as possible. Everything else being equal, a 10-year or 15-year note is worth more than a 30-year note.
- Other items that we consider to be positive when deciding whether to buy a note and how much to pay include:
- Property is owner-occupied (for houses and mobile homes).
- Access to power, water, and roads (for land).
- In regard to commercial notes, multi-unit apartments or general purpose office buildings are easier to place than specialty businesses like restaurants. A note on a property that was previously a gas station or anything that could have adverse environmental consequences will be much harder to sell due to the potential liability.
- The property and surrounding area being in good condition.

You'll also want to be sure that the sales price is not far above the market value (if you might someday sell the note) and that the title to the property is clean. If you have questions about structuring your note, feel free to contact us anytime.

Article written by Alan Noblitt of Seascape Capital Inc.

Sample Procedure for Administration of Standby Letters of Credit
Most Standby Letters of Credit are for domestic sales. Here is a sample step-by-step procedure for establishing a stand-by letter of credit in your organization:

Step 1
The Sales and Credit Departments agree that a standby letter of credit is necessary prior to communicating financial terms to the customer.

Step 2
The Credit Department will communicate the standby letter of credit terms to the customer. If a domestic letter of credit, an advising bank is not necessary; if an international letter of credit, an advising bank is necessary and thus, Credit will request that it be (name) Bank.

Step 3
Should the issuing bank's financial viability be unknown, the Credit Department will contact (name) Bank for a credit inquiry.

Step 4
Once the advising bank confirms the adequacy of the standby letter of credit and the financial viability of the issuing bank, the Credit Department will inform Sales and Traffic.

Step 5
Sales may ship the goods. However, prior to each shipment, Sales must inform the Credit Department of the total value of the goods to ensure that it does not exceed the protection allotted by the standby letter of credit. Credit and Sales should pay close attention to multiple shipments so that at no time does the credit exposure exceed the amount stated on the standby letter of credit.

Sample Procedure for Administration of Irrevocable Documentary Letters of Credit

Step 1
The Sales and Credit Departments agree that a irrevocable letter of credit is necessary prior to communicating financial terms to the customer. Sales and Credit must also agree whether to require an irrevocable confirmed or unconfirmed letter of credit.

Step 2
The Credit Department will communicate the letter of credit terms to the customer, forward a letter of credit checklist to the customer and try to select the issuing bank. Selecting the issuing bank is not always possible.
The Credit Department will also request that the customer forward a copy of the letter of credit on receipt. The customer generally receives its copy before our advising bank. Getting an early copy allows all parties at (your company) to begin the review process.

Step 3
The customer arranges with its bank for the issuance of the letter of credit.

Step 4
The issuing bank sends copies of the letter of credit to the customer and to our advising bank. Both, the customer and our advising bank will send a copy to the Credit Department.

Step 5
Once the Credit Department receives a copy of the letter of credit, it will send copies to Customer Service Representatives, Sales, and Traffic within one business day of receipt. Traffic personnel will forward the letter of credit to the forwarder. In addition, the Credit Department will log the letter of credit in the Letter of Credit Database.

Step 6
Credit, Sales, and Traffic will review the letter of credit looking for necessary amendments within one day of receipt. Reviewing parties will forward all amendments to the Credit Department via Fax or E-mail. A Fax or E-mail is still necessary should Sales or Traffic require no amendments.

Step 7
If amendments are necessary, the Credit Department will forward all required changes to the customer. Should the necessary amendments lie outside Credit's realm of expertise, it will seek the needed assistance from other areas within the Company. If the customer agrees, it will forward requests to its issuing bank, whom in turn will forward an amended letter of credit to our advising bank. Our advising bank will fax a copy of the amended letter of credit to Credit, who in turn will send it to Sales and Traffic. Credit, Sales, and Traffic will review the amended letter of credit to ensure no additional changes are necessary.
When making amendments and reviewing an amended letter of credit, it is important to keep the letter of credit's expiration date in mind. Credit should approximate the number of days taken up by the amendment process and amend the expiration date by the same number of days.

Step 8
If no changes are necessary, all the affected parties approve the amended letter of credit by notifying the Credit Department of the approval via Fax or E-mail within one day of receiving the amended letter of credit. If changes are necessary, go back to Step 6. Once the Credit Department receives the approval notifications from all parties, it will immediately advise all parties affected that the letter of credit has been approved.

Step 9
Sales sends a copy of the amended letter of credit to the plant with instructions to ship the product to the customer. Sales will do this on the same day it receives the notification from the Credit Department confirming that the amended letter of credit is acceptable.

Step 10
The Freight forwarder and Traffic Department ship the material and send all the documentation required in the letter of credit along with a draft for payment to our advising bank via overnight express courier.

Step 11
Our advising bank reviews all documentation to ensure that it complies with the letter of credit's requirements. If there are any correctable discrepancies, the advising bank will correct them. It is important to note that your advising bank may charge you for each discrepancy found and corrected. If there are non-correctable discrepancies, our advising bank will try to get the customer to waive them.
However, getting the customer to waive non-correctable discrepancies is no guarantee that the issuing bank will agree to the changes. This is especially true if the financial condition of the customer deteriorates. The advising bank's review process should take three days or less.

Step 12
Our advising bank forwards all the documents to the location specified in the letter of credit, which is usually the address of the issuing bank.

Step 13
The issuing bank honors the letter of credit and forwards the funds to our advising bank. Should the issuing bank not honor the letter of credit, it must tell our advising bank why.

Step 14
Our advising bank will credit our account minus applicable fees. All advising fees are absorbed by the division making the sale. The advising bank will contact the Credit Department stating whether or not payment has been received.

Should the issuing bank refuse to honor the letter of credit, we (seller company) are still responsible for associated fees.

The issue of who will pay for the associated fees should be resolved prior to accepting the letter of credit. The Buyer and the Seller should all be in accord. Although the seller typically pays for advising fees, all fees are negotiable.

Source: Credit Research Foundation

CRF thanks Ron Borcky for his development of this section

Purpose
The purpose of this document is to provide a general understanding of letters of credit, their use and application. The topics covered are the following:

General background information;

Types of letters of credit;

Common problems with letters of credit;

Procedures for establishing letters of credit;

Amendments; and

General tips to both buyers and sellers.

In addition, attachments to this document detail a step-by-step letter of credit procedures.

Definition
Letters of credit are commonly used to reduce credit risk to sellers in both domestic and international sales arrangements. By having a bank issue a letter of credit, in essence, one is substituting the bank's credit worthiness for that of the customer.

Types
There are two basic forms of letters of credit: Standby and Documentary. Documentary letters of credit can be either Revocable or Irrevocable, although the first is extremely rare. Irrevocable letters of credit can be Confirmed or Not Confirmed. Each type of credit has advantages and disadvantages for the buyer and for the seller, which this information will review below. Charges for each type will also vary. However, the more the banks assume risk by guaranteeing payment, the more they will charge for providing the service.

Documentary Revocable Letter of Credit
Revocable credits may be modified or even canceled by the buyer without notice to the seller. Therefore, they are generally unacceptable to the seller.

Documentary Irrevocable Letter of Credit
This is the most common form of credit used in international trade. Irrevocable credits may not be modified or canceled by the buyer. The buyer's issuing bank must follow through with payment to the seller so long as the seller complies with the conditions listed in the letter of credit. Changes in the credit must be approved by both the buyer and the seller. If the documentary letter of credit does not mention whether it is revocable or irrevocable, it automatically defaults to irrevocable. See Credit Administration, Sample Procedure for Administration of a Documentary Irrevocable Letters of Credit for a systematic procedure for establishing an irrevocable letter of credit.

There are two forms of irrevocable credits:
Unconfirmed credit (the irrevocable credit not confirmed by the advising bank)
In an unconfirmed credit, the buyer's bank issuing the credit is the only party responsible for payment to the seller. The seller's advising bank pays only after receiving payment from the issuing bank. The seller's advising bank merely acts on behalf of the issuing bank and, therefore, incurs no risk.

Confirmed credit (the irrevocable confirmed credit)
In a confirmed credit, the advising bank adds its guarantee to pay the seller to that of the buyer's issuing bank. Once the advising bank reviews and confirms that all documentary requirements are met, it will pay the seller. The advising bank will then look to the issuing bank for payment. Confirmed Irrevocable letters of credit are used when trading in a high-risk area where war or social, political, or financial instability are real threats. Also common when the seller is unfamiliar with the bank issuing the letter of credit or when the seller needs to use the confirmed letter of credit to obtain financing its bank to fill the order. A confirmed credit is more expensive because the bank has added liability.

Standby Letter of Credit
This credit is a payment or performance guarantee used primarily in the United States. They are often called non-performing letters of credit because they are only used as a backup should the buyer fail to pay as agreed. Thus, a stand-by letter of credit allows the customer to establish a rapport with the seller by showing that it can fulfill its payment commitments. Standby letters of credit are used, for example, to guarantee repayment of loans, to ensure fulfillment of a contract, and to secure payment for goods delivered by third parties. The beneficiary to a standby letter of credit can cash it on demand. Stand-by letters of credit are generally less complicated and involve far less documentation requirements than irrevocable letters of credit. See Credit Administration, Sample Procedure for Administration of a Standby Letter of Credit for a systematic procedure for establishing a standby letter of credit.

Special Letters of Credit
The following is a brief description of some special letters of credit.

Back-to-Back Letter of Credit
This is a new letter of credit opened based on an already existing, nontransferable credit used as collateral. Traders often use back-to-back arrangements to pay the ultimate supplier. A trader receives a letter of credit from the buyer and then opens another letter of credit in favor of the supplier. The first letter of credit serves as collateral for the second credit.

Deferred Payment (Usance) Letter of Credit
In Deferred Payment Letters of Credit, the buyer accepts the documents related to the letter of credit and agrees to pay the issuing bank after a fixed period. This credit gives the buyer a grace period for payment.

Red Clause Letter of Credit
Red Clause Letters of Credit provide the seller with cash prior to shipment to finance production of the goods. The buyer's issuing bank may advance some or all of the funds. The buyer, in essence, extends financing to the seller and incurs the risk for all advanced credits.

Revolving Letter of Credit
With a Revolving Letter of Credit, the issuing bank restores the credit to its original amount once it has been used or drawn down. Usually, these arrangements limit the number of times the buyer may draw down its line over a predetermined period.

Transferable Letter of Credit
This type of credit allows the seller to transfer all or part of the proceeds of the original letter of credit to a second beneficiary, usually the ultimate supplier of the goods. The letter of credit must clearly state that it is transferable for its to be considered as such. This is a common financing tactic for middlemen and is common in East Asia.

Assignment of Proceeds
The beneficiary of a letter of credit may assign all or part of the proceeds under a credit to a third party (the assignee). However, unlike a transferred credit, the beneficiary maintains sole rights to the credit and is solely responsible for complying with its terms and conditions. For the assignee, an assignment only means that the paying bank, once it receives notice of the assignment, undertakes to follow the assignment instructions, if and when payment is made. The assignee is dependent upon the beneficiary for compliance, and thus this arrangement is riskier than a transferred credit. Before agreeing to an assignment of proceeds arrangement, the assignee should carefully review the original letter of credit.

Common Problems with Letters of Credit
Most problems result from the seller's inability to fulfill obligations stated in the letter of credit. The seller may find these terms difficult or impossible to fulfill and, either tries to fulfill them and fails, or asks the buyer to amend to the letter of credit. As most letters of credit are irrevocable, amendments may at times be difficult since both the buyer and the seller must agree.

Sellers may have one or more of the following problems:

The shipment schedule cannot be met;

The stipulations concerning freight costs are unacceptable;

The price becomes too low due to exchange rates fluctuations;

The quantity of product ordered is not the expected amount;

The description of product is either insufficient or too detailed; and,

The stipulated documents are difficult or impossible to obtain.

Even when sellers accept the terms of a letter of credit, problems often arise late in the process. When this occurs, the buyer's and seller's banks will try to negotiate any differences. In some cases, the seller can correct the documents and present them within the time specified in the letter of credit. If the documents cannot be corrected, the advising bank will ask the issuing bank to accept the documents despite the discrepancies found. It is important to note that, if the documents are not in accord with the specifications of the letter of credit, the buyer's issuing bank is no longer obligated to pay.

Basic Procedures for Establishing a Letter of Credit
The letter of credit process has been standardized by a set of rules published by the International Chamber of Commerce (ICC). These rules are called the Uniform Customs and Practice for Documentary Credits (UCP) and are contained in ICC Publication No. 500. The following is the basic set of steps used in a letter of credit transaction. Specific letter of credit transactions follow somewhat different procedures.

1. After the buyer and seller agree on the terms of a sale, the buyer arranges for his bank to open a letter of credit in favor of the seller. Note: The buyer will need to have a line of credit established at the bank or provide cash collateral for the amount of the letter of credit.

2. The buyer's issuing bank prepares the letter of credit, including all of the buyer's instructions to the seller concerning shipment and required documentation.

3. The buyer's bank sends the letter of credit to the seller's advising bank.

4. The seller's advising bank forwards the letter of credit to the seller.

5. The seller carefully reviews all conditions stipulated in the letter of credit. If the seller cannot comply with any of the provisions, it will ask the buyer to amend the letter of credit.

6. After final terms are agreed upon, the seller ships the goods to the appropriate port or location.

7. After shipping the goods, the seller obtains the required documents. Please note that the seller may have to obtain some documents prior to shipment.

8. The seller presents the documents to its advising bank along with a draft for payment.

9. The seller's advising bank reviews the documents. If they are in order, it will forward them to the buyer's issuing bank. If a confirmed letter of credit, the advising bank will pay the seller (cash or a bankers' acceptance).

10. Once the buyer's issuing bank receives and reviews the documents, it either (1) pays if there are no discrepancies; or (2) forwards the documents to the buyer if there are discrepancies for its review and approval.

Opening a Letter of Credit
Level of Detail
The wording in a letter of credit should be simple, but specific. The more detailed an L/C is, the more likely the seller will reject it as too difficult to fulfill. At the same time, the buyer will wish to define in detail what its is paying for.

Type of Credit
Letters of credit used in trade are usually either irrevocable unconfirmed credits or irrevocable confirmed credits. In choosing which type to open both the seller and the buyer should consider the generally accepted payment processes in each country, the value and demand for the goods, and the reputation of the buyer and seller.

Documents
In specifying required documents, it is very important to include those required for customs and those reflecting the agreement reached between the buyer and the seller. Required documents usually include the bill of lading, a commercial and/or consular invoice, the bill of exchange, the certificate of origin, and the insurance document. Other documents required may be an inspection certificate, copies of a cable sent to the buyer with shipping information, a confirmation from the shipping company of the state of its ship, and a confirmation from the forwarder that the goods are accompanied by a certificate of origin. Prices should be stated in the currency of the letter of credit and documents should in the same language as the letter of credit.

The Letter of Credit Application
The following information should be addressed when establishing a letter of credit.

1. Beneficiary
The seller should provide to the buyer its full corporate name and correct address. A simple mistake here may translate to inconsistent or improper documentation at the other end.

2. Amount
The seller should state the actual amount of the letter of credit. One can request a maximum amount when there is doubt as to the actual count or quantity of the goods. Another option is to use words like "approximate", "circa", or "about" to indicate an acceptable 10 % plus or minus from the stated amount. For consistency, if you use this wording you will need to use it also in connection with the quantity.

3. Validity
The seller will need time to ship and to prepare all the necessary documents. Therefore, the seller should ensure that the validity and period for document presentation after the shipment of the goods is long enough.

4. Seller's Bank
The seller should list its advising bank as well as a reimbursing bank if applicable. The reimbursing bank is the local bank appointed by the issuing bank as the disbursing bank.

5. Type of Payment Availability
The buyer and seller may agree to use sight drafts, time drafts, or some sort of deferred payment mechanism.

6. Desired Documents
The buyer specifies the necessary documents. Buyers can list, for example, a bill of lading, a commercial invoice, a certificate of origin, certificates of analysis, etc. The seller must agree to all documentary requirements or suggest an amendment to the letter of credit.

7. Notify Address
This is the address to notify upon the imminent arrival of goods at the port or airport of destination. A notification listing damaged goods is also sent to this address, if applicable.

8. Description of Goods
The seller should provide a short and precise description of the goods as well as the quantity involved. Note the comments in step #2 above concerning approximate amounts.

9. Confirmation Order
With international arrangements, the seller may wish to confirm the letter of credit with a bank in its country.

Amendment of a Letter of Credit
For the seller to change the terms noted on an irrevocable letter of credit, it must request an amendment from the buyer. The amendment process is as follows:

The seller requests a modification or amendment of questionable terms in the letter of credit;

If the buyer and issuing bank agree to the changes, the issuing bank will change the letter of credit;

The buyer's issuing bank notifies the seller's advising bank of the amendment; and

The seller's advising bank notifies the seller of the amendment. Tips for Buyers and Sellers

Seller
1. Before signing a sales contract, the seller should make inquiries about the buyer's creditworthiness and business practices. The seller's bank will generally assist in this investigation.

2. In many cases, the issuing bank will specify the advising and/or confirming bank. These designations are usually based on the issuing bank's established correspondent relationships. The seller should ensure that the advising/confirming bank is a financially sound institution.

3. The seller should confirm the good standing of the buyer's issuing bank if the letter of credit is unconfirmed.

4. For confirmed letters of credit, the seller's advising bank should be willing to confirm the letter of credit issued by the buyer's bank. If the advising bank refuses to do so, the seller should request another issuing bank as the current bank may be or is in the process of becoming insolvent.

5. The seller should carefully review the letter of credit to ensure its conditions can be met. All documents must conform to the terms of the letter of credit. The seller must comply with every detail of the letter of credit specifications; otherwise the security given by the credit is lost.

6. The seller should ensure that the letter of credit is irrevocable.

7. If amendments are necessary, the seller should contact the buyer immediately so that the buyer can instruct the issuing bank to make the necessary changes quickly. The seller should keep the letter of credit's expiration date in mind throughout the amendment process.

8. The seller should confirm with the insurance company that it can provide the coverage specified in the letter of credit and that insurance charges listed in the letter of credit are correct. Typical insurance coverage is for CIF (cost, insurance and freight) often the value of the goods plus about 10 percent.

9. The seller must ensure that the goods match the description in the letter of credit and the invoice description.

10. The seller should be familiar with foreign exchange limitations in the buyer's country that could hinder payment procedures.

Buyer
1. When choosing the type of letter of credit, the buyer should consider the standard payment methods in the seller's country.

2. The buyer should keep the details of the purchase short and concise.

3. The buyer should be prepared to amend or re-negotiate terms of the letter of credit with the seller. This is a common procedure in international trade. With irrevocable letters of credit, the most common type, all parties must agree to amend the document.

4. The buyer can reduce the foreign exchange risk by buying forward currency contracts.

5. The buyer should use a bank experienced in foreign trade as its issuing bank.

6. The validation time stated on the letter of credit should give the seller ample time to produce the goods or to pull them out of stock.

7. A letter of credit is not fail-safe. Banks are only responsible for the documents exchanged and not the goods shipped. Documents in conformity with the letter of credit specifications cannot be rejected on grounds that the goods were not delivered as specified in the contract. The goods shipped may not in fact be the goods ordered and paid for.

8. Purchase contracts and other agreements pertaining to the sale between the buyer and seller are not the concern of the issuing bank. Only the letter of credit terms are binding on the bank.

9. Documents specified in the letter of credit should include those the buyer requires for customs clearance.

Source: Credit Research Foundation

Understanding and Using Letters of Credit, Part I

Letters of credit accomplish their purpose by substituting the credit of the bank for that of the customer, for the purpose of facilitating trade. There are basically two types: commercial and standby. The commercial letter of credit is the primary payment mechanism for a transaction, whereas the standby letter of credit is a secondary payment mechanism.

Commercial Letter of Credit
Commercial letters of credit have been used for centuries to facilitate payment in international trade. Their use will continue to increase as the global economy evolves.

Letters of credit used in international transactions are governed by the International Chamber of Commerce Uniform Customs and Practice for Documentary Credits. The general provisions and definitions of the International Chamber of Commerce are binding on all parties. Domestic collections in the United States are governed by the Uniform Commercial Code.

A commercial letter of credit is a contractual agreement between a bank, known as the issuing bank, on behalf of one of its customers, authorizing another bank, known as the advising or confirming bank, to make payment to the beneficiary. The issuing bank, on the request of its customer, opens the letter of credit. The issuing bank makes a commitment to honor drawings made under the credit. The beneficiary is normally the provider of goods and/or services. Essentially, the issuing bank replaces the bank's customer as the payee.

Elements of a Letter of Credit

- A payment undertaking given by a bank (issuing bank)
- On behalf of a buyer (applicant)
- To pay a seller (beneficiary) for a given amount of money
- On presentation of specified documents representing the supply of goods
- Within specified time limits
- Documents must conform to terms and conditions set out in the letter of credit
- Documents to be presented at a specified place

Beneficiary
The beneficiary is entitled to payment as long as he can provide the documentary evidence required by the letter of credit. The letter of credit is a distinct and separate transaction from the contract on which it is based. All parties deal in documents and not in goods. The issuing bank is not liable for performance of the underlying contract between the customer and beneficiary. The issuing bank's obligation to the buyer, is to examine all documents to insure that they meet all the terms and conditions of the credit. Upon requesting demand for payment the beneficiary warrants that all conditions of the agreement have been complied with. If the beneficiary (seller) conforms to the letter of credit, the seller must be paid by the bank.

Issuing Bank
The issuing bank's liability to pay and to be reimbursed from its customer becomes absolute upon the completion of the terms and conditions of the letter of credit. Under the provisions of the Uniform Customs and Practice for Documentary Credits, the bank is given a reasonable amount of time after receipt of the documents to honor the draft.

The issuing banks' role is to provide a guarantee to the seller that if compliant documents are presented, the bank will pay the seller the amount due and to examine the documents, and only pay if these documents comply with the terms and conditions set out in the letter of credit.

Typically the documents requested will include a commercial invoice, a transport document such as a bill of lading or airway bill and an insurance document; but there are many others. Letters of credit deal in documents, not goods.

Advising Bank
An advising bank, usually a foreign correspondent bank of the issuing bank will advise the beneficiary. Generally, the beneficiary would want to use a local bank to insure that the letter of credit is valid. In addition, the advising bank would be responsible for sending the documents to the issuing bank. The advising bank has no other obligation under the letter of credit. If the issuing bank does not pay the beneficiary, the advising bank is not obligated to pay.

Confirming Bank
The correspondent bank may confirm the letter of credit for the beneficiary. At the request of the issuing bank, the correspondent obligates itself to insure payment under the letter of credit. The confirming bank would not confirm the credit until it evaluated the country and bank where the letter of credit originates. The confirming bank is usually the advising bank.

Letter of Credit Characteristics

Negotiability
Letters of credit are usually negotiable. The issuing bank is obligated to pay not only the beneficiary, but also any bank nominated by the beneficiary. Negotiable instruments are passed freely from one party to another almost in the same way as money. To be negotiable, the letter of credit must include an unconditional promise to pay, on demand or at a definite time. The nominated bank becomes a holder in due course. As a holder in due course, the holder takes the letter of credit for value, in good faith, without notice of any claims against it. A holder in due course is treated favorably under the UCC.

The transaction is considered a straight negotiation if the issuing bank's payment obligation extends only to the beneficiary of the credit. If a letter of credit is a straight negotiation it is referenced on its face by "we engage with you" or "available with ourselves". Under these conditions the promise does not pass to a purchaser of the draft as a holder in due course.

Revocability
Letters of credit may be either revocable or irrevocable. A revocable letter of credit may be revoked or modified for any reason, at any time by the issuing bank without notification. A revocable letter of credit cannot be confirmed. If a correspondent bank is engaged in a transaction that involves a revocable letter of credit, it serves as the advising bank.

Once the documents have been presented and meet the terms and conditions in the letter of credit, and the draft is honored, the letter of credit cannot be revoked. The revocable letter of credit is not a commonly used instrument. It is generally used to provide guidelines for shipment. If a letter of credit is revocable it would be referenced on its face.

The irrevocable letter of credit may not be revoked or amended without the agreement of the issuing bank, the confirming bank, and the beneficiary. An irrevocable letter of credit from the issuing bank insures the beneficiary that if the required documents are presented and the terms and conditions are complied with, payment will be made. If a letter of credit is irrevocable it is referenced on its face.

Transfer and Assignment
The beneficiary has the right to transfer or assign the right to draw, under a credit only when the credit states that it is transferable or assignable. Credits governed by the Uniform Commercial Code (Domestic) maybe transferred an unlimited number of times. Under the Uniform Customs Practice for Documentary Credits (International) the credit may be transferred only once. However, even if the credit specifies that it is nontransferable or nonassignable, the beneficiary may transfer their rights prior to performance of conditions of the credit.

Sight and Time Drafts
All letters of credit require the beneficiary to present a draft and specified documents in order to receive payment. A draft is a written order by which the party creating it, orders another party to pay money to a third party. A draft is also called a bill of exchange.

There are two types of drafts: sight and time. A sight draft is payable as soon as it is presented for payment. The bank is allowed a reasonable time to review the documents before making payment.

A time draft is not payable until the lapse of a particular time period stated on the draft. The bank is required to accept the draft as soon as the documents comply with credit terms. The issuing bank has a reasonable time to examine those documents. The issuing bank is obligated to accept drafts and pay them at maturity.

Standby Letter of Credit
The standby letter of credit serves a different function than the commercial letter of credit. The commercial letter of credit is the primary payment mechanism for a transaction. The standby letter of credit serves as a secondary payment mechanism. A bank will issue a standby letter of credit on behalf of a customer to provide assurances of his ability to perform under the terms of a contract between the beneficiary. The parties involved with the transaction do not expect that the letter of credit will ever be drawn upon.

The standby letter of credit assures the beneficiary of the performance of the customer's obligation. The beneficiary is able to draw under the credit by presenting a draft, copies of invoices, with evidence that the customer has not performed its obligation. The bank is obligated to make payment if the documents presented comply with the terms of the letter of credit.

Standby letters of credit are issued by banks to stand behind monetary obligations, to insure the refund of advance payment, to support performance and bid obligations, and to insure the completion of a sales contract. The credit has an expiration date.

The standby letter of credit is often used to guarantee performance or to strengthen the credit worthiness of a customer. In the above example, the letter of credit is issued by the bank and held by the supplier. The customer is provided open account terms. If payments are made in accordance with the suppliers' terms, the letter of credit would not be drawn on. The seller pursues the customer for payment directly. If the customer is unable to pay, the seller presents a draft and copies of invoices to the bank for payment.

The domestic standby letter of credit is governed by the Uniform Commercial Code. Under these provisions, the bank is given until the close of the third banking day after receipt of the documents to honor the draft.

Procedures for Using the Tool
The following procedures include a flow of events that follow the decision to use a Commercial Letter of Credit. Procedures required to execute a Standby Letter of Credit are less rigorous. The standby credit is a domestic transaction. It does not require a correspondent bank (advising or confirming). The documentation requirements are also less tedious.

Step-by-step process:

- Buyer and seller agree to conduct business. The seller wants a letter of credit to guarantee payment.
- Buyer applies to his bank for a letter of credit in favor of the seller.
- Buyer's bank approves the credit risk of the buyer, issues and forwards the credit to its correspondent bank (advising or confirming). The correspondent bank is usually located in the same geographical location as the seller (beneficiary).
- Advising bank will authenticate the credit and forward the original credit to the seller (beneficiary).
- Seller (beneficiary) ships the goods, then verifies and develops the documentary requirements to support the letter of credit. Documentary requirements may vary greatly depending on the perceived risk involved in dealing with a particular company.
- Seller presents the required documents to the advising or confirming bank to be processed for payment.
- Advising or confirming bank examines the documents for compliance with the terms and conditions of the letter of credit.
- If the documents are correct, the advising or confirming bank will claim the funds by:
a) Debiting the account of the issuing bank.
b) Waiting until the issuing bank remits, after receiving the documents.
c) Reimburse on another bank as required in the credit.
- Advising or confirming bank will forward the documents to the issuing bank.
- Issuing bank will examine the documents for compliance. If they are in order, the issuing bank will debit the buyer's account.
- Issuing bank then forwards the documents to the buyer.

Standard Forms of Documentation
When making payment for product on behalf of its customer, the issuing bank must verify that all documents and drafts conform precisely to the terms and conditions of the letter of credit. Although the credit can require an array of documents, the most common documents that must accompany the draft include:

Commercial Invoice
The billing for the goods and services. It includes a description of merchandise, price, FOB origin, and name and address of buyer and seller. The buyer and seller information must correspond exactly to the description in the letter of credit. Unless the letter of credit specifically states otherwise, a generic description of the merchandise is usually acceptable in the other accompanying documents.

Bill of Lading
A document evidencing the receipt of goods for shipment and issued by a freight carrier engaged in the business of forwarding or transporting goods. The documents evidence control of goods. They also serve as a receipt for the merchandise shipped and as evidence of the carrier's obligation to transport the goods to their proper destination.

Warranty of Title
A warranty given by a seller to a buyer of goods that states that the title being conveyed is good and that the transfer is rightful. This is a method of certifying clear title to product transfer. It is generally issued to the purchaser and issuing bank expressing an agreement to indemnify and hold both parties harmless.

Letter of Indemnity
Specifically indemnifies the purchaser against a certain stated circumstance. Indemnification is generally used to guaranty that shipping documents will be provided in good order when available.

Common Defects in Documentation
About half of all drawings presented contain discrepancies. A discrepancy is an irregularity in the documents that causes them to be in non-compliance to the letter of credit. Requirements set forth in the letter of credit cannot be waived or altered by the issuing bank without the express consent of the customer. The beneficiary should prepare and examine all documents carefully before presentation to the paying bank to avoid any delay in receipt of payment. Commonly found discrepancies between the letter of credit and supporting documents include:

- Letter of Credit has expired prior to presentation of draft.
- Bill of Lading evidences delivery prior to or after the date range stated in the credit.
- Stale dated documents.
- Changes included in the invoice not authorized in the credit.
- Inconsistent description of goods.
- Insurance document errors.
- Invoice amount not equal to draft amount.
- Ports of loading and destination not as specified in the credit.
- Description of merchandise is not as stated in credit.
- A document required by the credit is not presented.
- Documents are inconsistent as to general information such as volume, quality, etc.
- Names of documents not exact as described in the credit. Beneficiary information must be exact.
- Invoice or statement is not signed as stipulated in the letter of credit.

When a discrepancy is detected by the negotiating bank, a correction to the document may be allowed if it can be done quickly while remaining in the control of the bank. If time is not a factor, the exporter should request that the negotiating bank return the documents for corrections.

If there is not enough time to make corrections, the exporter should request that the negotiating bank send the documents to the issuing bank on an approval basis or notify the issuing bank by wire, outline the discrepancies, and request authority to pay. Payment cannot be made until all parties have agreed to jointly waive the discrepancy.

Tips for Exporters

- Communicate with your customers in detail before they apply for letters of credit.
Consider whether a confirmed letter of credit is needed.
- Ask for a copy of the application to be fax to you, so you can check for terms or conditions that may cause you problems in compliance.
- Upon first advice of the letter of credit, check that all its terms and conditions can be complied with within the prescribed time limits.
- Many presentations of documents run into problems with time-limits. You must be aware of at least three time constraints - the expiration date of the credit, the latest shipping date and the maximum time allowed between dispatch and presentation.
- If the letter of credit calls for documents supplied by third parties, make reasonable allowance for the time this may take to complete.
- After dispatch of the goods, check all the documents both against the terms of the credit and against each other for internal consistency.

Summary
The use of the letters of credit as a tool to reduce risk has grown substantially over the past decade. Letters of credit accomplish their purpose by substituting the credit of the bank for that of the customer, for the purpose of facilitating trade.

The credit professional should be familiar with two types of letters of credit: commercial and standby. Commercial letters of credit are used primarily to facilitate foreign trade. The commercial letter of credit is the primary payment mechanism for a transaction.

The standby letter of credit serves a different function. The standby letter of credit serves as a secondary payment mechanism. The bank will issue the credit on behalf of a customer to provide assurances of his ability to perform under the terms of a contract.

Upon receipt of the letter of credit, the credit professional should review all items carefully to insure that what is expected of the seller is fully understood and that he can comply with all the terms and conditions. When compliance is in question, the buyer should be requested to amend the credit.

Source: Credit Research Foundation

Cash-strapped residents still have an option before turning to Medicaid.

Viatical settlements, a financial resource for the terminally or chronically ill, have been around for more than a decade. But most people know little, if anything, about them. For residents of senior congregate living facilities, which include nursing homes, assisted living facilities and independent living communities, they can be a lifeline - the answer to their needs for immediate cash for a variety of reasons. These can include upgrading their living quarters to a private room, paying for costly experimental treatments not covered by traditional insurance plans or giving financial relief to family members.

Viatical settlements allow individuals with terminal or chronic illnesses to sell their life insurance policies for cash. They first became a financial planning tool in the mid-1980s in response to the AIDS epidemic. Viaticals changed the way we view insurance policies. Once regarded only as a benefit to surviving family members, life insurance policies soon became viewed as an existing asset, much like stocks and bonds, real estate and savings accounts.

Viaticals were particularly appropriate for People With AIDS (PWAs) because they had a life-limiting illness, which, at the time, had a very predictable term. In many cases, PWAs had limited access to medication and hospital care because they lost their jobs and health benefits when they became ill. Many died destitute. In recent years, viaticals have become more mainstream and are benefiting people with a broader range of life-limiting illnesses. In addition to PWAs, they include people of all ages with terminal illnesses, as well as residents of senior congregate living communities. Viatical settlements are becoming increasingly popular among seniors who require immediate cash for a wide range of needs.

Since most residents and their families are probably unfamiliar with viatical settlements, it is in their best interests - and those of management, social workers and others in direct contact with residents - to make them aware of this financial resource. Financial planning counsel can be just as important to a resident's well-being as the attention given to his medical, social, psychological and intellectual needs.

A viatical settlement is a way to access cash and reduce financial strains and resulting emotional unrest for both the resident and family. It makes the life insurance policy a valuable financial asset that can improve the quality of the resident's remaining years.

The following is a basic overview of viatical settlements and the key questions that management and personnel dealing directly with residents might want to address.

What is a viatical settlement?

The word "viatical" comes from the Latin word "viaticum," which refers to the necessary money or supplies given to a person embarking on a long or difficult journey. In the Christian church, "viaticum" is the blessing of the Eucharist given to provide spiritual sustenance to a dying person or one in danger of death.

A viatical settlement is a contract that allows an individual with a relatively short life expectancy to sell a life insurance policy for cash to a third party - an individual or business entity - at a discounted value of the policy's face value. Simply, the person gets cash in exchange for relinquishing the death benefits of the life insurance policy to the person paying for it, less a certain percentage of the benefit. The amount that the viator - the seller of the policy - receives depends upon his/her life expectancy. The viator can get as much as 80% of the policy's face value. Basically, the less time they have left to live, the more money they get.

By viewing a life insurance policy as a current asset, the insured can now access funds - the death benefits - virtually immediately as a living benefit.

The elderly might need the cash for a variety of reasons, although the needs of those with life-limiting conditions are often quite basic, but costly. Having these needs met can reduce the older person's emotional strains and subsequently improve his or her health. These needs could include:

* Paying for experimental treatments not covered by traditional medical insurance policies;

* Paying for nursing home or assisted living community care if family members are footing the bill;

* Moving to a private room, perhaps a larger one with more luxuries and conveniences, such as a private phone;

* Having a private nurse;

* Paying travel expenses for family visits to the facility;

* Funding educational costs for a grandchild;

* Making a gift to a loved one.

Nearly every type of life insurance policy qualifies for a viatical settlement, providing it's been in force for at least two years. The process is simple:

To determine the life expectancy of the viator, the viatical settlement company has a board of physicians evaluate the person's illness, basing their findings on medical records, laboratory reports and current actuarial tables. The viator then receives the cash payment after transferring ownership of the life insurance policy to the viatical settlement provider. The entire process takes about a month. The policy is then maintained by the viatical settlement company, which also pays the premiums.

What about taxes?

The federal government has established strict guidelines governing the viatical industry. Most significant is the 1996 Health Insurance Portability & Accountability Act which exempts viators from paying federal income tax on these settlements if they are terminally or chronically ill. The Act defines a terminally ill person as one with a medically certified life expectancy of less than 24 months. A chronically ill person is defined as one who is unable to perform at least two activities associated with daily living. Only in these qualified situations are viatical settlements tax-free. Furthermore, individuals qualifying for this tax-free benefit must use a viatical settlement provider who is licensed in the state where they live. In some states, funds are also exempt from state taxes.

Are viaticals for the healthy?

Now, anyone over the age of 70 with a life insurance policy who is in serious need of money can qualify for what is called a "senior settlement," an increasingly popular option. These people may be perfectly healthy or may have suffered a heart attack or stroke or have other ailments they can live with indefinitely. However, given their age and statistical data, they are candidates for such a settlement, based on actuarial life expectancy tables established by insurance companies. The shortcoming here is that a senior settlement is not tax-free.

What are the risks?

The risks for the family are clear: The children or other survivors are no longer the beneficiaries of the insurance policy. They've waived their rights to the proceeds. It has been sold and the buyer, who's now paying the premiums, will receive the death benefits. It's up to the resident and family to decide. A viatical settlement is but one financial option, but it is one that can provide convenient access to much-needed cash.

Michael Zadoff is president and founder of Dedicated Resources, Inc., a viatical settlement company in Delray Beach, Florida. Founded in 1988, it is one of the oldest viatical settlement companies in the United States.

Growing firms often find themselves strapped for money. A gap in cash is created when bills are paid weeks before cash comes in from customers. The cash gap can be shortened by concentrating efforts on fast moving inventory, implementing a just-in-time inventory model, negotiating extended credit terms to suppliers, and getting cash out of customers through discount programs and credit card transactions. Only after exhausting these alternatives does factoring typically make sense.

Factoring provides quick access to cash through sales of receivables. The cash gap is shortened to the extent factoring brings in money earlier than receivables normally would. In general, firms that sell receivables immediately receive a percentage of the outstanding accounts sold. Once the receivables are paid, the factor forwards the balance of these collected accounts to the firm less a factoring fee. This article describes typical factoring arrangements and the costs/benefits of this form of financing. Fees can be high but may outweigh the costs of lost sales, ventures, opportunities, or at the extreme, going out of business.

A survey of small to medium sized businesses that use factoring provides a consumer profile of typical factoring arrangements. A majority of those surveyed are young, rapidly expanding organizations using factoring to support short-term entrepreneurial expansion efforts. Firms report that factoring typically provides access to seventy to ninety percent of cash tied up in receivables, with the balance provided within sixty to ninety days less a ten to twelve percent fee. In all, those that use factoring report high satisfaction, and often use the same factor on a repeat basis.

Spending Money to Make Money

It's not uncommon to hear about emerging companies that grow themselves right out of business. Cash demands often stall expansion efforts when bills are paid weeks before cash comes in from customers. Spending money to make money can be costly. The cash gap between payments deserves careful consideration. Rapidly expanding companies with excellent products and booming sales are hamstrung if receivables tie up cash needed to fund operations and growth. Understanding the factors that affect the time between payments affords a closer look at managing the cash gap and alternative financing options.

The Cash Gap

Managing the cash gap is illustrated in Exhibit 1. When a company pays its suppliers before it collects from its customers, the cash drain presents a financing need. The gap between payments is managed by getting cash out of inventory quickly all-the-while avoiding payment to suppliers as long as possible. Concentrating purchasing efforts on fast moving inventory, giving discounts to customers who pay early, and negotiating extended credit terms with suppliers all help to reduce the cash gap.

Robbing Peter to Pay Paul

Small cash gaps are best. When inventory is purchased, sold, and collected in the same amount of time it takes to pay for the goods the cash gap closes to zero. Even better, a negative cash gap is a modern day version of robbing Peter to pay Paul. Customer Peter advances payment before the inventory is paid to Paul supplier. For example, customers of E-commerce companies like amazon.com forward credit card payments for books brought in on a just-in-time basis and paid for under thirty-day credit terms following the sale. Under this scenario, amazon.com maintains a negative thirty-day cash gap. Likewise, in the specialty cement business, customers pay for goods six to eight weeks before they are manufactured and shipped. In this case, the negative cash gap of forty to sixty days provides an internal source of financing.

To illustrate how the cash gap works refer to Exhibit 2. If a company spends an average of $10,000 per day on its operations, and it takes 100 days to convert its investment in the production process into cash (a 100 day cash gap), then this firm will require roughly $ 1,000,000 in funding (on average) to support its operations ($10,000/day x 100 days). However, if this company can find a way to reduce its cash gap to say 50 days, then only $500,000 in funding is required. Finally, if we assume the cost of financing is 10% annually, this company could reduce its annual financing costs from $100,000 to $50,000 per year.

Small Business Constraints

Unlike large, publicly traded firms, small businesses face a variety of operating and financial constraints that limit the extent to which they can close the cash gap. Many small firms face technological and managerial constraints that limit the ability to closely monitor (and hence reduce) inventory levels. Furthermore, small firms are more likely to lack the power that large corporations have in negotiating terms from suppliers. Finally, small businesses do not possess the same resources to devote toward the collection of accounts receivable. These small firms typically have limited access to short term financing alternatives to help short-term working capital needs. Obtaining working capital from banks can be difficult, time-consuming, and paper-intensive. Willing lenders are often hard to find.

Reducing the Cash Gap in Small Businesses

What options remain for small businesses interested in reducing the cash gap? One alternative is to turn the inventory/sales cycle upside down. Replicate the Ecommerce model. Provide incentives for customers to pay cash upfront. Implement a just-in-time inventory system that affords the option of paying for inventory after the cash sale. In this way, the cash gap becomes negative.

A close second option that shortens the cash gap is to provide incentives for customers to charge their purchases using VISA or MasterCard. Credit card companies buy receivables for a one to five percent fee. If the customer factors (sells) the receivable by charging the purchase, little cost is involved, cash is obtained within days, and the cash gap shortens considerably. Cash discounts given to customers who pay early achieve a similar result.

Only when trade and industry expectations hamper efforts to accelerate customer payments should consideration be given to factoring existing receivables. Factoring receivables involves selling customer invoices to a third party at a discounted amount. Instant money is obtained without collateral or extensive corporate credit. The factor becomes the bill collector, assuming the majority of the risk of collecting payment. The fee charged by the factor may be as high as five percent in the first month due to the lack of collateral or extensive credit review. Alternatively, if the receivables are sold with recourse, accomplished by a "validity guarantee," the factor may charge a smaller fee in exchange for the right to hold the corporation liable for uncollected receivables. Limited time is spent underwriting the credit of the business and its customers, examining the track record of the business' collection ability and the payment history of its customers. Audited financial statements are not obtained and the risk of fraudulent misrepresentation can amount to one-half to one percent of those factored. Understandably, many receivables are factored with recourse to mitigate the factor's risk and the resulting fees imposed.

Factoring Industry

The basic need for factoring originated from the practice of merchants extending beneficial "trade credit" to purchasers of their product or service -- a concept that has been around for over 3,000 years. More specifically, the extension of credit occurs when a business sells merchandise to a purchaser, usually another business, but allows the purchaser time -- usually 30, 60, or 90 days -- in which to pay the bill. Unless the seller has sufficient funds in reserve during the "credit period," continued production efforts are hampered.

Although factors have existed for thousands of years, the impact of high interest rates on businesses in the 1970's generated renewed interest in factoring. Even after interest rates fell significantly, factoring continued to fill an ever-widening gap in the financial structure of our economy, especially with restricted bank financing. Because of the savings and loan debacle, lending institution loan portfolios are subject to greater scrutiny and stricter standards. As a result, the factoring industry has experienced rapid growth -- increasing from $46 billion in factored receivables in 1993 to over $100 billion in 1995.

The factoring industry can be divided into two broad groups that serve two distinctively different market segments. The first group consists of the factoring divisions of banks and other financial institutions such as Morgan Guarantee Trust Company, American Express, Citicorp, and Citibank, which provide receivables financing to their large corporate customers. These financial institutions will usually limit their purchases to $1,000,000 or more per invoice and charge relatively low fees -- usually around 1 to 3 discount points. Numerous large Fortune 500 companies such as Western Digital, Honeywell, Georgia Pacific, and Scott Paper factor receivables through the factoring divisions of large financial institutions.

The second group of factors consists of small, privately owned financial services companies. These smaller factors generally fund new, rapidly growing companies that have exhausted their lines of credit and borrowing capacity at banks, and have few other working capital financing alternatives available to them. For these growth companies, factoring is an attractive means of raising capital. Small factors will purchase invoices as little as $1,000 or as much as $500,000.

Realistically, only those companies experiencing cash drains from growing sales typically utilize this type of financing strategy. However, struggling companies with cash flow problems also use factors in an attempt to increase cash flow. If a struggling company needs cash to begin turning its business around then this financing strategy may be effective. However, companies that are financially weak may have to sell their receivables at a greater discount than strong companies. Therefore, struggling companies often experience difficulty factoring in the long run. Also, factors will purchase only those receivables that they consider collectable. This means that companies with poorly managed receivables may find that factoring is not an option.

Factoring

In a typical factoring arrangement, a business sells its accounts receivable to a factor at a discount, receives between 60% and 90% of the face amount of the invoice up front, and pays the factor between one percent and five percent of the face value of the invoice per 30 days. The balance of the receivable is remitted when the factor recovers its cash outlay. For example if ABC Company sells a $10,000 receivable to a factor, ABC Company might receive $7,000 cash immediately (70%). At the end of thirty days, assuming ABC's customer remits the balance to the factor, ABC will receive the remaining $2,500 less a 5% ($500) discount, which represents profit to the factor.

Factoring is a financing tool. The money can be used to purchase inventory needed for growing sales or perhaps to take advantage of supplier discounts by reducing payables early. Factoring also allows a company to increase its capital without taking on additional debt or selling more stock. Other benefits include improved credit ratings resulting from prompt debt repayment, internal cost savings by reducing the time and money committed to managing receivables which provides managers with more time to focus on growing the business. Companies that factor are often growing rapidly and have exhausted lines of credit and borrowing capacity at banks.

However, factoring has its drawbacks. Fees increase as the risk of noncollection escalates. Depending on the quality of the receivables, fees may reach five percent in the first month and higher in the weeks that follow. State usury laws regulating interest rate caps on borrowings, such as 18% in Florida or 24% in New York, do not apply. Factoring is considered a sale, not a loan. Factoring fees typically amount to ten to twelve percent on receivables paid within sixty to ninety days.

Despite the high fees, factoring benefits may outweigh the costs. For instance, losing out on 12% of the receivables to gain 88% immediately may be wise if cash is needed to accept a new contract promising repeat business or expansion into a new market that otherwise would have been forgone. For companies with strong receivables, losing out on 3% of receivables that typically take sixty days to collect may make sense if those receivables cost the company more than 3% in fees (interest, billing and collection) during the collection period.

Exhibit 3 illustrates the benefits of factoring. For a company with $1,800,000 in sales and $1,620,000 in operating costs, receivables that are collected every two months carry an average balance of $300,000. A moderate factoring fee may be assumed if the receivables are assumed to be high quality (i.e. government contracts) and take little time to be paid in full. Using factoring rates advertised by 21st Capital (www.21stcapital.com), the factoring fee is $27,000 or nine percent of the $300,000 receivables. Annualized, this fee amounts to $162,000, or nine percent of the $1,800,000 sales.

Factoring fees may be offset by the interest saved by shortening the cash gap. The portion of the cash gap related to receivable collection, sixty days, is shortened to the extent that cash is received early. The annual interest saved is $21,600. The interest savings taken together with the savings in accounts receivable collection and billing functions estimated at $30,000 provides a net annual cash outflow from factoring of $110,400 or 6.13% of sales. In this example, the benefits of factoring may outweigh the costs to the extent factoring brings in cash needed to fund additional projects or growth in excess of 6.13% of sales.

If the company is in desperate need of cash and factoring is ignored, a business may be forced to employ its last alternative -- selling part of the business to outsiders. For many small business owners, selling part of a business may be difficult and an unacceptable alternative.

The Cost and Characteristics of Non-Bank Factoring Arrangements

A survey of smaller businesses utilizing accounts receivable factoring as a source of financing was conducted to assess the nature, costs, and characteristics of non-bank factoring arrangements. The survey was mailed in October 1999 to small businesses that used the services of factors within the past three years. The list and mailing addresses of businesses using factoring services was obtained from the client-lists of three Florida-based non-bank factors. The survey was designed to assist in creating a profile of businesses that utilize factoring. In addition, the survey explored the level of satisfaction businesses have with their factoring companies as well as the costs relative to other sources of short-term working capital financing. A total of 633 surveys were mailed and 59 were returned resulting in a response rate of 7.9%.

Sample Firm Characteristics

Most of the respondents to this factoring survey (58%) have been in business for five years or less (see Exhibit 4). This appears to be consistent with the notion that startup firms with short track records and operating histories have difficulty getting bank financing and turn to factoring. When asked directly whether they had problems obtaining traditional bank financing, Exhibit 5 shows that 64% of respondents reported they had approached three or more banks for lines of credit and 54% reported being rejected for bank financing three or more times. Only 9% of those surveyed reported they had not been turned down for a loan or line of credit at least once. In general, the responses suggest many small, young businesses that factor receivables are considered risky candidates for traditional financing sources.

Sample firms reported average sales levels of approximately $800,000 in 1996, $1,000,000 in 1997 and an $1,800,000 projection for 1998. A majority of these firms (64%) operate in a main facility that is less than 5,000 square feet, while thirty percent are housed in facilities 5,000-10,000 square feet and only six percent occupy spaces in excess of 10,000 sq. ft. Small businesses that factor have small facilities and are experiencing sales growth.

Consistent with an increasing sales trend, respondents report high expectations of growth (Exhibit 6). Nearly sixty percent of the respondents plan to add new products or services, forty eight percent expect to enter new markets, and thirty nine percent anticipate adding operating space to their facility. These businesses that factor fit a startup entrepreneurial profile.

The Factoring Relationship

Given the drains on cash from sales growth, the respondents were asked how frequently they factor. The responses indicate factoring is used almost equally as a short term or long term financing alternative. One third of the firms reported using factoring less than six months, thirty-- eight percent factored for six months to a year, and twenty-nine percent factored for more than a year. Most firms (83%) use one factor. Respondents in need of a factoring arrangement often do so repeatedly with the same financing source. As anticipated, Exhibit 7 illustrates that factoring serves a strong need for growing companies. A large number of firms report factoring kept them from bankruptcy (31%) or from turning down sales (39%).

The benefits of factoring are evidenced in the survey results that indicate 60% of firms received an up front cash advance ranging from 70% to 90% of the value of the receivables factored (see Exhibit 8). Less than five percent received over 90%. Surprisingly, nearly twenty percent of firms received less than 50% against the value of receivables.

Factoring fees experienced by the respondents are provided in Exhibit 9. While the largest percentage of surveyed firms paid two to two-and-one-half discount points per 30 days, this is still an expensive source of capital. While there might be a tendency to view this fee on an annualized basis (2.5% for 30 days amounts to nearly 35% on a compound annualized basis), recall that typical fees are paid over two to three months on decreasing receivable balances. A compounded fee for the year at 35% would be incurred only in the unlikely scenario that the same receivable remains uncollected for twelve months with imposition of the 2.5% rate compounded monthly throughout that time.

Despite the cost, a majority of firms appear to be quite satisfied with their factoring relationship. Seventy percent of the firms reported they were satisfied with their factoring relationship, while only 14% found this relationship to be unsatisfactory.

Summary and Conclusions

Growing firms often find themselves strapped for cash. When bills are paid weeks before cash comes in from customers, the cash gap between payments represents a financing need. The cash gap can be shortened by concentrating efforts on fast moving inventory, implementing a just-in-- time inventory model, negotiating extended credit terms to suppliers, and getting cash out of customers through discount programs and credit card transactions. Only after exhausting these alternatives does factoring typically make sense.

Factoring provides quick access to cash through sales of receivables. The cash gap is shortened to the extent factoring brings in cash earlier than receivables normally would. This article describes typical factoring arrangements and the costs/benefits of this form of financing. Fees can be high but may outweigh the costs of lost sales, ventures, opportunities, or at the extreme, going out of business.

A survey of businesses that use factoring reports many are young, rapidly expanding companies using factoring as a short-term financing alternative. Factoring typically affords companies access to seventy to ninety percent of cash tied up in their receivables, with the balance provided within sixty to ninety days less a ten to twelve percent fee. In all, those that use factoring report high satisfaction, and often use the same factor on a repeat basis.

Daniel J. Borgia, Ph.D. is an Assistant Professor of Finance and Deanna O. Burgess, Ph.D. is an Assistant Professor of Accounting for the College of Business at Florida Gulf Coast University

Ned Amos, owner of Amos Plumbing Co., was in a bind. As a subcontractor on a large project, he had a contract for $100,000. But 60 days after completing phase one and billing his general contractor for $28,000, he was still waiting for payment and running low on funds to operate his business.

"I had several plumbers there, laborers, backhoe operators--the whole nine [yards]. I had payroll to meet and material bills," explains Amos, 29, owner of the one-and-a-half-year-old St. Louis company.

Since Amos had a new business with little collateral and had yet to establish a track record, he knew he couldn't get a bank loan to cover expenses until the general contractor paid up. So he went to a factoring company.

Factors buy a company's invoices, advance them 60% to 80% of the face value, and then give them the rest when the debtor pays, minus the factor's 2% to 4% fee.

For example, Amos sold his $28,000 invoice to Quantum Corporate Funding Ltd. in New York. They advanced him 60%, or $16,800. When the general contractor paid Quantum, Quantum gave Amos the remaining 40%, less its 4% fee, or $10,080.

Factoring is a financing option for young, undercapitalized businesses that have the profit margins to absorb the factor's fee. The business may need the money to meet expenses or to go after other projects. Factors buy an invoice based on its creditworthiness; they don't need a small business' financial statements.

Factoring, which used to be the exclusive domain of the garment industry, is expanding into manufacturing, distribution and the service industry, says Leonard Machlis, executive director of the Commercial Finance Association, a New York-based national trade association for factors and asset-based lenders.

Part of that expansion is due to an increase in the number of nontraditional factors, which factor for small to midsize businesses on an as-needed basis.

Traditional factors, which factor million-dollar deals on a continuing basis, still comprise the vast majority of the $70-billion-a-year factor business, he adds.

Factoring is not for every business. Here's what to consider:

* Markup: Only those with a gross margin of at least 20% should consider factoring, says Paul Goldstein, president of Atlanta-based Presidential Financial Corp.

That means if your business has a profit margin of 20%, you are still making 16% to 18% after paying a factor's fees. But if your business has a profit of 10%, you are losing a third of your profit by factoring.

* Interest rates: With an average 30-day interest rate of 2% to 4%, factors are more expensive than banks.

"In factoring, however, it's not appropriate to annualize it out and say you're paying more than 36% a year [with a 3% fee]," says Craig Sheinker, president of Quantum; "because we don't require the client to use us any more than he needs us. He can use us for one invoice and never again."

* Credit protection: Factors are nonrecourse lenders. If the business--whose invoice the factor owns--files for Chapter 11 bankruptcy protection, the factor loses and the client keeps the advance. In addition, some factors will investigate the creditworthiness of a company before entering into a contract.

* Timing: Small businesses may use a factor intermittently for a couple of years until they've established a track record. Once they are creditworthy, they can then apply for unsecured money.

"We're the minor leagues in the banking business, says Sheinker. "We're the farm team. If they prove themselves with us, they get drafted and move up to the big boys."

From Black Enterprise Magazine

For more information on construction factoring feel free to call us toll free at 877-836-4661

Many people who have obtained structured settlements through their personal injury or workers' compensation claims wonder if they should try to sell their settlement in return for a lump sum payment. This may be a relatively modest curiosity, piqued by an advertisement announcing "It's your money!" and promising cash payment. Or it may be based upon an immediate need for funds. However, selling a structured settlement is not always possible, and it is not necessarily an economically wise decision.

Your Structured Settlement Should Work For You
The best time to decide that a structured settlement is not right for you is before you consent to such a settlement. You may wish to press for a lump sum settlement, for periodic lump sum payments in addition to smaller annual payments, or for a lump sum to be issued at a future date when you anticipate a particular need. If you work out a settlement package that is in your best interest at the outset, you will be able to maximize the value of your settlement and get the greatest tax benefit from the structured portion of any settlement.

Remember that the companies which purchase structured settlements intend to profit from the purchase of your settlement. Their profit comes out of the payments you would otherwise receive.

Recall also that if your future earning capacity is impaired as a result of your injury, you should consider your future needs when you are making any decision regarding the sale of your settlement.

Restrictions on Selling Settlements
There are laws in approximately two thirds of the states which restict the sale of structured settlements, and additional federal regulations apply to the sale of tax-free structured settlements. It may be necessary to obtain court approval for the buy-out. The insurance company that issued the annuities for the structured settlement may refuse to cooperate with the sale of a settlement, citing policy language and asserting that payments cannot be assigned.

Tax Consequences
As a typical structured settlement is designed to provide significant tax advantages to the injured plaintiff, there can be significant tax consequences associated with selling part or all of a settlement. It may be that, while payments made under the settlement were not taxed, the lump sum received through the sale of the settlement will be taxed.

Shop Around For Offers
If you are approached about selling your settlement, or are looking for a buyer, don't take the first offer you receive. You will almost always benefit from consulting with different brokers or buyers in relation to your settlement. You should also take care that you are working with an established, reputable buyer.

Consult A Lawyer
It is wise to consult a lawyer in relation to the sale of your settlement before signing a contract. A lawyer can help ensure that your rights are protected, and that you will not be subject to consequences for events outside of your control, for example if the company which purchases your settlement is later unable to collect payments from the insurance company which issued the annuities in your settlement package. A lawyer will be able to tell you if the terms of the purchase agreement are reasonable, and may also be able to advise you as to whether the offer made for your settlement is adequate.

Article from ExpertLaw

What Is a Structured Settlement?
Sometimes when a plaintiff settles a case for a large sum of money, the defendant, the plaintiff's attorney, or a financial planner consulted in association with the settlement, will propose paying the settlement in installments over time rather than in a single lump sum. When a settlement is paid in this manner it is called a "structured settlement". Often the structured settlement will be created through the purchase of one or more annuities, which guarantee the future payments.

A structured settlement can provide for payment in pretty much any schedule the parties choose. For example, the settlement may be paid in annual installments over a number of years, or it may be paid in periodic lump sums every few years.

Benefits of a Structured Settlement
One significant advantage of a structured settlement is tax avoidance. With appropriate set-up, a structured settlement may significantly reduce the plaintiff's tax obligations as a result of the settlement, and may in some cases be tax-free.

A structured settlement can protect a plaintiff from having settlement funds dissipated, when they are necessary to pay for future care or needs. Sometimes a structured settlement can help protect a plaintiff from himself - some people simply aren't good with money, or can't say no to relatives who want to "share the wealth", and even a large settlement can be rapidly exhausted. Minors may benefit from a structured settlement as well, such as a settlement which provides for certain costs during their youth, an additional disbursement to pay for college or other educational expenses, and then one or more disbursements in adulthood. An injured person who has long-term special needs may benefit from having periodic lump sums with which to purchase medical equipment or modified vehicles.

In some situations, it will be better for a severely disabled plaintiff to set up a special needs trust, rather than entering into a lump sum or structured settlement. Any plaintiff who is receiving, or expects to receive, Medicaid or other public assistance, or the guardian or conservator entering into a settlement on behalf of a disabled ward, should consult with a disabilities financial planner about t