Factoring, or receivable financing is the sale of your invoices or accounts receivable to a third party. It is very dominant in certain industries, i.e. trucking and transportation, staffing, etc. What differentiates factoring is really the three points we’ll discuss – who is offering it to you, what it costs, and how does it work.
So let’s get back to our three key areas: First factoring firms vary by size, geography, and financial capability. You need to align yourself with a party that is most suited to your type of business, the size of your receivables portfolio, and the ability to deal on a one on one basis on any issues that come up. Your best partner will be a firm who as direct representation in your geographical area.
Is factoring expensive? Receivable financing can appear to be expensive, and unfortunately most borrowers are always focus on rate. A few key points need to be made, so let’s be clear on this issue. First of all factoring usually has a discount rate of between 1-3% per month. We use the term discount rate because the industry itself doesn’t view the rate as an interest rate; it views it as essentially a reduction in your overall gross margin. Let’s use a quick, clear example. Let’s say you have an invoice for $ 100,000.00. Factoring allows you to get approx 90% of the funds on that invoice the day you generate the invoice. (The balance, 10%, is paid to you when your customer pays,) and out of that holdback comes, say a 2% discount fee to the factor firm) the factor industry view that 2% as a commission for financing your invoice. If your customer pays in 30 days, you would have paid 2% per month, that’s 24% per annum that is expensive. Now compare this with the accepting of credit cards where the discount rate is typically 2.5% – 3% or even more!
By factoring and getting immediate cash, you may be able to purchase inventory at a better price for cash, or alternatively, you can take the many 2% net ten day discounts many suppliers offer. If that was the case on all your business we can make the statement that you are recovering 100% of your financing costs via this strategy, plus you have unlimited working capital.
Summary of Factoring Benefits
- Meet increasing sales demand
- Grow your business
- Avoid “collection” hassles
- Buy in bulk and receive discounts
- Meet payroll.
- Avoid payroll and estimated tax delinquencies
- No personal guarantee required