We're looking at factoring accounts receivable. What do I need to know about this or accounts receivable financing?
I would only use that as a last resort. It is a very expensive financing strategy. I would rather truncate terms or impose a financing charge on the delinquents. Regular monitoring of accounts receivable should, hopefully, preclude the need.
Factoring has become so inexpensive that it has become a llegitimate alternative for companies who are bound by longer terms from class A customers. I recently came across an factoring opportunity that cost 1.5% over LIBOR for the days early. Also in Europe it has been more commonplace.
I would like to learn more about it especially in the European market. I have credit insurance, but would like to learn more.
The challenge for those of us in the factoring industry has always been that small business owners are either unfamiliar or misunderstand what it’s for and how it works.
Critics of course make a bee line for the cost of funds – which, of course, is relative. The fact of the matter is, factoring accounts receivable is far less expensive than the ROI an equity investor will take as a partner in your company.
The cost of funds is directly tied to the consideration that in certain situations small businesses cannot secure institutional bank financing. There may be a variety of reasons, obviously tightening of credit in this economy being one of them. The simple reason factoring costs relatively more is due to the extensive mechanics of the funding process. First, the factor has a borrowing base and is also paying interest. The factor will (for the benefit of the borrower) investigate the creditworthiness of each account debtor (customer) who owes on the invoices. The factor will need to notify and verify each customer regarding their invoice (this may vary slightly depending on the individual company.) All this ends up being built into the final yield a factor will anticipate for putting money out on the street.
So what does the client get for all this? The biggest plus is the access to capital to grow your business. The factor company will base its decision to fund on the creditworthiness of the customer after checking the goods or services have been accepted and completed. If you have invoices, you have access to working capital that is waiting on your balance sheet.
Additionally, speed of that access if a huge benefit. Generally a factor company can set up a relationship in a few days with minimal paperwork and subsequently fund each new invoice within 24 hours. A good factoring company can do all of this with only the slightest intrusion into the day to day operations of a business.
So the fundamental answer to the question has less to do with cost of funds; it should be about the day to day relationship you have with your factor. You are looking for a lender who is always available, has a professional operation with the proper amount of experience. It’s important to find a factor that does a lot of funding in your particular industry vertical. You want to ask about how they do the credit checks and how they do the invoice verifications. Ask about mandatory contract periods and monthly minimum funding requirements. Because working with a factoring company requires process, you want to have a firm that is easy to work with who will help your business grow.
In my opinion, one of the most significant factors in making this decision not addressed above is concentration of credit. I had a Client once that if they financed their business by utilizing a factor, they would still be in business today. They had a great model, the right time in the right marketplace, but their concentration of customers caused them to fall when the largest account filed for bankruptcy.