Factoring Accounts Receivable What is Factoring? If your business accepts credit cards, you are “factoring” in an indirect manner. When you accept a credit card, you also pay a fee to the credit card company/bank. In exchange for getting the money wired immediately into your account, you have “sold” your invoice to that credit card company for a discount.
This brings us to the definition of a true factor. A factor buys your current accounts receivables at a discounted rate. This means that you get the money from an invoice immediately, instead of waiting 30, 60 or even 90 days for your customers to pay. However, since there is a discount, you get less money than if you decided to wait to collect your receivables yourself. Depending on the size of your company and your customers, and the average amount of time they take to pay invoices, a discount rate can range from 2 to 15 percent.
Factors first started in the apparel and textile industries. Today, they are common in many industries.
Some funding companies refer to their programs as “lines of credit.” Although they are not “true lines of credit,” the similarity lies in the fact that you will have an advance of cash available. Unlike bank lines of credit, which you can outgrow because banks have a maximum cap on their lines, once your company grows and you need a higher amount of money, it is always available — just as long as you have customers that are creditworthy and you submit those receivables.
When Does Factoring Make Sense for a Small Company?
Factoring makes sense when:
- -your company is too new for other types of borrowing,
- -your business customers have good credit ratings,
- -the sales cycle is long requiring your company to wait 30, 60, or 90 days to receive payment,
- -slow paying customers are putting a damper on your growth,
- -you have a large purchase order that you can’t fulfill without having up-front money for raw materials, cash payments to vendors, assemblies, etc.
- -you don’t want to create additional debt by obtaining a loan.
- -you’ve exhausted all other traditional routes to working capital.
When is Factoring Not a Good Idea ?
- -When you can get a loan from one of the traditional sources (i.e., bank) at a very low interest rate.
- -When your outstanding orders or accounts receivable are somewhat unreliable.
- -When you have customers that pay you immediately or within a reasonable time frame that doesn’t cause any strain on the business.
Tips for getting money.
Look to a broker to assist you in arranging factoring. Brokers will take your company information to a funding source that can best meet your needs. If you’re not satisfied with what is offered, a broker can assist you in negotiating the fine details in your proposal or even work to get you another offer from another company, if necessary. Working with a broker enables you to keep your mind and energy on your business while the broker does all of the “leg work”. Brokers can find funding companies that specialize in businesses that have $5,000/month in receivables as well as $25 million/month in receivables. Best of all, most brokers do not charge a fee for the service they provide, even though they represent you.
Where can you find a broker: When you contact a company that offer this service, ask if you’re dealing with a broker or a factor. You might think it best to just deal with the factor from the start, but if you deal with the broker, he/she will continue to search for the best company and the best proposal for you without you taking your mind off of the business. The factor will make you one deal: theirs.
Show the funding company that your cash flow problem is just that — and not the tip of an iceberg-sized operational problem. If you’ve got good, reliable customers who pay on time and who aren’t credit risks, they’ll be good “risks” for a factor too.
Remember: a factoring company and a collection agency are two entirely different entrees — you could say that one is a “meat lovers dish,” while the other is the “vegetarian’s delight.” Don’t expect the factor to take problematic accounts off of your hands in order to collect your payments. If your company is large, most factors will audit your accounts before they buy them to make sure they meet their own credit standards, and most likely will have limits — such as only taking accounts that pay off in certain time periods.
Ingredients you have on hand.
You’ll need to complete and sign an evaluation application. This step gives the factor the authority to “pop up” your customers on a computer screen so they can see your customer’s credit history. By the way, your credit history will also be seen — the better it is, the better your proposal — although this is NOT a determining ingredient as to whether or not you will get a satisfying proposal.
You’ll need your most current aging receivables report, articles of incorporation (if applicable), a sample invoice, and, in some cases, you’ll need a copy of your most recent financial statement. If you’re seeking purchase order financing, add to the pot, a copy of the contracts/purchase orders, summary of cost breakdowns, and a copy of your contractors license ( if applicable).
A “due diligence fee” will be required when you have agreed to the proposal (whether it’s verbally or via a letter of intent). This is a ONE TIME fee that ranges between $150 – 600 for small to mid-sized businesses. If the company is larger, this fee is evaluated on an individual basis. The fee covers administrative costs to open your account, to conduct lien and UCC searches, filing fees and any other general out-of-pocket expenses.
Be wary of the 800 pound gorilla who could twirl you around by the tail in this kind of relationship. Always, always, always — am I stressing this enough? — ask questions regarding terms, conditions, terminations, etc. before “signing on the dotted line.” You need to make certain there aren’t any surprises; this can be a very beneficial relationship, as long as everything is completely understood.
Most factors work with your receivables on a “non-recourse” basis. This is your best type of relationship — it’s a sort of insurance that covers YOU! For instance, if a factor gives you an advance on an invoice and later that company responsible for that invoice declares bankruptcy, you DO NOT have to pay back that advance. The factor takes the loss. (Whew!)
If you have legal counsel, have a conference call with the factor and your legal counsel. Make the funding source discuss all of the details and have your attorney ask about anything that’s not stated plainly in the contracts.
Having your own business can feel like an incredible sense of accomplishment. Having cash flow problems can be like an incredible case of indigestion. Having to depend on someone else (a factor) to pull you through, can feel like a burning ulcer — have extra antacid in your drawer to help you through those times!
Remember: you will have a more consistent cash flow that permits you to pay your debts earlier. Ask your suppliers/vendors for discounts. For instance, tell them you will pay them the day you receive your shipment and not in 30 or 60 days (whatever your agreement may be) if they give you a 10% discount. Most vendors prefer to get their money earlier too, and this will help offset the costs of factoring. Ask your broker how to make this program most flexible for you — you can still feel in control and maintain the costs you incur at a lower level, if you learn “easy tricks of the trade.”
After evaluating the relationship you can establish with a factor, take advantage of this financial tool that has been made available to you and grow, grow, grow!
What types of factoring programs are on the menu?
Factors will work with commercial receivables only because they depend on the creditworthiness of your customers. Therefore, your receivables are the ONLY collateral.
There are factors that service general commercial business, construction, medical, and international invoices. Some funding companies also provide purchase order financing (some do this on a stand-alone basis, others combine it with your receivables funding account).
Some factors offer “term contracts,” while others don’t — it’s on an as need basis.
Watch out for!
Don’t get addicted to factoring — you can really get used to having your payments within 24 hours. Once this relationship is no longer profitable, end it amicably.
After 12 to 24 months, your financials are much more attractive. You may want to seek alternative financial assistance (i.e., from your bank). If you outgrow your bank’s program, you can always go back to a factoring agreement.
ALWAYS make certain that your factoring company has strict confidentiality policies. Some factoring companies like to advertise which businesses they’ve assisted — tell them they cannot do this without your consent.