Factoring provides funding from receivables

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Factoring can be traced back to the Roman Empire and was the dominant form of finance in the American colonies before the Revolution (mainly for textile firms). In the 1930s, factors began to expand their businesses beyond textiles. |ret||ret||tab|

Over the past few decades, consolidation has created two distinct types of funding sources: large, institutionally owned factors and several small, independent factoring firms.|ret||ret||tab|

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What is factoring?|ret||ret||tab|

Factoring is the purchase of a business's accounts receivable at a discount. Rather than wait 30, 45, 60 days or longer for the receivable to be paid, the factor purchases the invoice and advances most of the balance up front. The client first completes an application, which includes a list of the receivables to be factored. The funding source then submits a proposal to the client, which includes an estimate of the factor fee. |ret||ret||tab|

If the client accepts the proposal, the next step is for due diligence to be performed. The factor must research not only the client, but more importantly the credit standing of the debtors. After the due diligence review, the factor advances 70 percent to 80 percent of the invoice balance to the client. |ret||ret||tab|

When the customer pays the invoice, which is made directly to the factor, the client receives the remaining balance less the factor's fee, which typically ranges anywhere from 3 percent to 6 percent. The whole process can take as little as a week after the application has been approved.|ret||ret||tab|

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Why use factoring?|ret||ret||tab|

The company is in a high-growth mode. Consider this situation: You own a profitable, growing manufacturing company that has used up the credit lines extended to it by the bank. A customer comes in with a large order that needs to be filled soon. You must come up with the cash for production or let the order go to a competitor, which might cause you to lose the customer forever. |ret||ret||tab|

Factoring existing receivables could provide the financing to maintain market share and increase profits.|ret||ret||tab|

Survival. In this scenario which is thought by many to be the only reason, the company's cash flow is so tight that it must have the cash now to fund payroll, pay taxes and meet expenses. |ret||ret||tab|

The company simply can't wait for a customer to pay the bill 45 days down the road. In this situation, factoring often becomes an ongoing relationship.|ret||ret||tab|

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Benefits of factoring|ret||ret||tab|

Elimination of bad debt. A non-recourse factor will assume the risk of bad debt, thus eliminating this expense from your income statement.|ret||ret||tab|

Professional collections. Not only will a good factor collect receivables in a professional manner which enhances customer relations, he will eliminate overhead incurred from the collection process. |ret||ret||tab|

Unlimited capital. Factoring is the only source of financing that grows with your sales. As sales increase, more cash becomes available for you to use, which allows you to constantly meet demand.|ret||ret||tab|

Take advantage of volume and early payment discounts. With improved cash flow, you will be in a position to take advantage of these discounts, which directly effect the bottom line.|ret||ret||tab|

No debt incurred. Factoring is not a loan, and therefore you are not incurring any debt. This keeps your balance sheet looking good, making it easier to obtain other types of financing or to sell the company.|ret||ret||tab|

Factoring is easy and fast. The application required to establish a factoring relationship is much simpler than other types of financing. No tax returns, financial statements, business plans, or projections are needed.|ret||ret||tab|

No personal guarantees. The company principals do not have to personally guarantee the repayment of the funding. They usually have to guarantee against fraud or disputes, but not against customers' inability to pay.|ret||ret||tab|

Invoices are paid faster. Factors generally report payment experiences to Dun & Bradstreet or other credit agencies. A debtor who is aware of this will not want his credit impaired.|ret||ret||tab|

Credit screening. A factor will provide you with credit information on new customers, thus allowing you to make better credit decisions.|ret||ret||tab|

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Common objections |ret||ret||tab|

Too expensive. When I recently told a lawyer friend about receivables funding, his immediate reaction was, "That's about the most expensive form of financing there is." |ret||ret||tab|

On the face of it, it is expensive, but what needs to be considered are the value of the benefits described above. |ret||ret||tab|

Overhead savings, bad debt elimination and faster payments are all occurrences that can improve cash flow.|ret||ret||tab|

You don't want customers to know you're factoring. You're worried they might view your company in a negative light, but there's really no reason to feel that way. |ret||ret||tab|

You should simply tell your customers that you have chosen to use an accounts receivable management company in order to concentrate on operations and administrative costs.|ret||ret||tab|

Loss of control. A good factor will actually provide you with more control over your business by issuing timely management reports which you probably don't produce internally. |ret||ret||tab|

In addition, factors usually monitor changes in the credit standing of your customers, which allows you to make intelligent credit decisions.|ret||ret||tab|

Fear of mistreatment of customers. A factor isn't a collection agency. The last thing they want to do is alienate your customers. If an invoice is past due, you have the option of contacting them directly.|ret||ret||tab|

Receivables funding may not be for everyone, but it should be viewed with an open mind.|ret||ret||tab|

(Kent Harlan is a CPA in private business and owner of Ozarks Capital Funding.)|ret||ret||tab|

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