Factoring A Business Solution?

FACTORING
So what is it?

Factoring is when a business sells its outstanding customer invoices to a third party (a factor) to get immediate cash, instead of waiting 30-90 days for payment. In short, it’s a way to obtain cash quickly if you aren’t a cash heavy business.

Think of it this way…sometimes you may have a profitable business, but large gaps in between you converting those invoices into actual cash in your bank to pay the bills. This is where some utilize factoring to gain that cash almost instantly and then only lose a small amount to the third party…or so they think!

I’m not saying it’s a bad gig for you, but you lose money in factoring every time as they’ll take fees off of what you planned to make originally which means profit margins aren’t as expected. No way around that. So, you need to uncover if this is the route for your business long term or if only in the short term before realizing thousands in fees or “advance rate” costs to the factoring company. (more on that below)

GOOD OR BAD
You decide

Let’s go over a few things of when it’s good to use and a few Pro’s and Con’s I’ve uncovered over the years of seeing this with clients/companies.

Some find value in this when:
1. They have fast growth, but slow customer payments due to terms.
2. Seasonality in their business (i.e. holidays, summer, winter, etc.).
3. Not qualifying for business loans even though they have strong receivables.
4. Brand new company that’s still finding their business cycle.
5. Need to meet short term obligations like loans or payroll.

Here’s a real world example for you from my own experience in dealing with Factoring with a client. Client factored all AR as they did not know how to handle/manage receivables. This was costing their business almost $250k annually in fees. Our AR services are top notch and provide very detailed policies and steps on how to manage AR. We stepped in, implemented a strategy, and 2 months later they reduced factoring by 50%. Fast forward to month 6 and ALL of their AR management was in house saving this business $250k annually. Factoring helps, but in most cases we can help you!

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THE PROS
How it can help

Here’s a few of the Pro’s when it comes to businesses utilizing a factoring company to help with cash flow.

1. Immediate working capital. Cash in the bank in a few days vs months so you can make payroll, pay vendors, etc.

2. No new debt on your books. Converted quickly so it doesn’t show up on the balance sheet at the end of a month.

3. Outsources collections (in some cases). Recourse vs Non-Recourse factoring basically.

   Recourse means you are responsible if the customer ends up not paying the factoring company.

   Non-Recourse means the onus falls on the factoring company if the customer defaults on paying the outstanding invoice(s).

THE CONS
Finding out the hard way

Along with good things always means there can be a downside so here’s what I’ve come across to keep in mind.

1. It’s not cheap – effective annual rates can be high and per transaction costs add up, plus monthly fees.

2. May impact relationships with clients if they’re contacted for payment.

3. Not all receivables qualify (bad credit customers are risky). Another reason to vet your customers up front to know how financially healthy they really are.

Advance Rate is how much the factoring company is willing to pay you for the receivables. This can vary, but I’ve seen anywhere from 70-90% plus monthly fees based on contract, volume, etc. Here’s an example if you’re still confused as to how this works or what it is, but please keep in mind this is one type of scenario and if you were to explore factoring for your business the layout, format of the deal, fees, final payments, etc. may vary from my example!

Contact me if you’d like to network or partner together. I’d love to chat with you more about the services I offer on the side through Guernsey Consulting. If you do not know, I work full time in Treasury Management and then do consulting on the side. Would love to chat or network with you about it.

Some of those services are listed below that we can help you with!

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