MMOIA

By Dale Edwin Miller

Factoring is a financial instrument has been around since ancient times, but is barely understood by today’s modern small business owners. Used correctly, it is a tool that can help small businesses survive and grow.

First let’s understand what factoring is not. Factoring companies are not interested in collecting debts that would be debt collection companies. Factoring companies, in fact, hate poor paying accounts so much so that they may refuse them or charge a very high rate for them. Factoring is for business to business type accounts for companies that are billing other companies, so retailing and food service is out for factoring.

Factoring is one business selling its invoice to a factor. The factor, advances a portion of the money to the selling company, and then when the companies customer pays, it pays the factor. The factor then rebates a portion of the total amount of the invoice (less the advance) and keeps an agreed upon percentage called the discount rate.

For example, Suppose ABC Company is selling widgets to XYZ Company, but XYZ Company takes 45 days to pay. ABC Company can not wait that long, and sell its invoice to LMN Factoring Company. Suppose ABC sells XYZ $100.00 worth of widgets. ABC then sells its invoice to LMN Factors. LMN factors wire to ABC Companies accounts $90.00 (creating a 90% advance rate). After 45 days XYZ Company pays LMN factors the amount of the invoice or $100.00. LMN Factors then wires $8.00 (more) to ABC Company and keeps $2.00, the discount rate.

The advance rate and discount rate are agreed upon when first coming to an arrangement with the factoring company. The process is fairly straight forward.

A customer or a broker will meet with a particular company to review if a factoring arrangement would be a viable financial instrument. If so the factoring company would ask for a signed client profile, a copy of a recent chart of the business accounts receivable, and articles of incorporation. The factoring company will then verify that the business is a going concern, that ownership is legitimate, and then begin to pull Dun and Bradstreet reports or ratings on those companies listed in the A/R chart of accounts. If the companies are satisfactory, then the factor will make arrangements to purchase the accounts from these companies if the invoices are submitted by the client company (which may submit one or all depending on their particular needs). At this time the advance and the discount rate will be agreed upon.

Many factoring companies specialize in certain market segments, such as Manufacturing, Wholesaling, or Technology to mention a very few. A perspective business owner can waste a lot of time searching this out for him or herself. This is where a broker can be of great assistance. Brokers are independent sales people, but many have background in commercial credit. Brokers also have formed relationships with factoring companies and know which companies specialize in certain segments. Unfortunately, very few brokers advertise. So where do you find a good reputable broker? Try your local banker, maybe if you have just been turned down for a small business loan, the banker can recommend a local broker who can help you for 18-24 months as you become more “bank ready.”

CPA’s are also a good source to use as they may have contacts for financing solutions that are “out of the box.”

I heard factoring is expensive. Well maybe, but relative to what? Is factoring more expensive that bank financing, probably. Consider however the following points. The factoring company provides your company with professional credit approval. If you submit a “hot new customer” that the factor wants no part of, maybe your company better insist on cash or credit card as terms of doing business. There are no loan covenants to keep with a factor, no quarterly reports or account reviews which eat up time and money.

The discount fee maybe written off, similar to interest payments, check with your accountant to see the details in your state. The loan can not be called early and there are no personal guarantees (except for fraud).A business may factor as many or as few invoices or even accounts as it wishes (pending initial approval).

Factoring can be a powerful financial tool for a business with the right structure. It is definitely worth checking into if your business needs help to grow or survive.