Fast Cash from Factoring

Q: We’ve been approached by a “factoring” firm-they’re offering to buy our accounts receivable. What should we be watching out for?

A: Commercial factors have long provided financing to big and small companies in the trucking business, as well as non-bank financing to firms that need to quickly raise cash, whether due to the seasonal aspects of their industry or a lack of working capital. (After all, your fuel supplier doesn’t care if your customer is extending you 45 days).

A factoring company buys your receivables for a percentage of the value of the invoice. You’re paid cash, and the factoring company then assumes the responsibility-and the risk-for collecting the amount. It’s not much different than what happens when a retailer accepts a credit card: you receive the money often within 24 hours, while the factoring company waits for payment.

By factoring your receivables, you don’t increase debt or dilute equity. You’re simply given access to your own money when you want it rather than when your customer chooses to pay. You don’t have to sell every receivable. You can do it at the frequency you think you need, and the volume you need. As you build your own working capital, you can reduce the amount that you factor and carry more of your own accounts receivable.

Now, my company is in this business, but I have no problem telling you that factoring is not for everyone. The idea behind factoring is to use a factor’s money to make more money. If it can’t be demonstrated that by factoring you can increase business, then you should give it a pass.

Also, while factoring companies assume the risk of collections, we need to protect ourselves and are looking for reasonable assurance that the customer will pay, so we evaluate the ability of the customer to pay and his credit history.

Factoring is more expensive (typically 3% to 5% of your invoice) than most other forms of finance, so it’s important to find ways to build that cost into your price and earn it back.

There are also savings realized by not having to perform credit functions yourself. If you can use the factoring monies to add new business, then the costs of factoring are fairly easy to justify.