In today's world we can't escape the doom-and-gloom press, and the constant reminders about the bad economy and tight credit. But here's the good news. There are a variety of funding sources, in addition to bank financing, for companies with no prior credit, less than favorable credit, or inadequate credit lines.
One alternative is factoring, or accounts receivable financing. Factoring is the process of selling your outstanding receivables in order to get immediate payment; instead of waiting for a customer to pay in 30, 60 or 90 days. Factoring is not a loan. It's the sale of a valuable asset just like equipment or any other hard asset. In fact, ARs can be one of the most valuable assets on your balance sheet. The approval process is based on the credit quality of your customer, not on your own credit rating. So factoring can be a popular alternative for new companies with thin credit history, growing firms who need additional cash to take on new or larger clients, and established companies who want to limit the use of their bank credit line in order to protect their credit rating.
But isn't factoring expensive? The average discount rate across all industries is now about 3% for a 30-day invoice. It's a financial vehicle that's common in Europe and Asia, and becoming popular in the U.S. This trend means that factors are starting to compete for your business, which is causing discount rates to fall.
The process includes three steps. First, you sell an invoice to a factor. Second, the factor sends you the "advance," which is typically 80-90% of the dollar amount of the invoice. And they hold back a 10-20% "reserve." Third, when the factor receives payment from your customer, he releases the reserve less the discount.
Here's an example with an 85% advance rate, and a 3% discount on a 30-day invoice. You sell a $1,000 invoice, and receive $850 within 24 hours. When your customer pays the invoice within 30 days, you get an additional $120 and the factor retains a $30 fee. So at the end of 30 days you get $970 for a $1,000 invoice.
Typical factoring clients include: architects, engineers, construction companies, transportation companies, building suppliers, security firms, custodial firms, temporary staffing, manufacturers, machine shops, printers, and printing suppliers. In fact, any company with commercial invoices and credit-worthy customers can be an appealing candidate for a factor.
Discount rate is a primary consideration when evaluating an offer. The average discount across all business categories is about 3% for a 30-day invoice. This fee may be tax deductible as a business expense, but always work closely with your accountant to stay on top of any changes to the tax laws. It's easy to find offers touting rates as low as 1%, but be careful. It's critical to calculate the "effective rate." Many low rate offers include a variety of fixed and variable fees that drive up the actual cost.
There are a variety of options from "spot" to "relationship." Spot factoring is a one-time transaction. Relationship involves ongoing transactions, and the higher volume allows you to negotiate a lower discount. Many factors now agree to "relationship" rates with no monthly minimum volume and no set term limit. Keep in mind that factors are more flexible than banks, and more willing to negotiate.
You might want to consider working with a factoring broker, because they can save you time and money. They locate the best factor to meet your unique business needs. Then they negotiate the terms for you, and teach you the "tricks" to minimize fees.

Phyllis Brown is the principal at Capital Consulting Group, New York, N.Y. Tags: