When evaluating financial services, one needs to employ proper due diligence to avoid costly traps

We all know the expression, "Penny wise and pound foolish." And unfortunately when it comes to financial services you need to do your homework to avoid this trap. The Quick Example A simple example is credit card rates and fees, with which we're all very familiar. You make an informed decision to accept a credit card offer based on the APR (annual percentage rate), and your projections for revolving vs. transacting activity. This calculation provides you with a projected annual expense for using your credit card for monthly purchases. If you project a high volume of revolving, then you'll choose a low APR. But if your cash flow is stable, then the APR is irrelevant as you pay in full each month. Or some consumers and/or small business people use their card to the full credit limit every two weeks, and pay their balance in full twice per month without waiting for the monthly bill. This pay-as-you-go approach isn't recommended unless you closely monitor your spending, in order to stay below the credit limit and avoid over limit fees. But there are a number of issues to consider in addition to APR. Teaser rates may increase after the initial term. The bank will charge over limit fees, balance transfer fees, late fees, etc. In addition if payments are late a default rate can take effect, which could exceed 24% in this tight credit environment. Plus credit lines can be reduced if when balances consistently exceed 40% of the full credit limit. And APR and/or fees can increase at any time, as long as the credit card company provides written notice and the option for you to stop using the card until the balance is paid in full. So for all practical purposes the card was just cancelled, and your line of credit just disappeared. So it's important to look always at the effective rate, which includes additional fees on top of APR. Rate is the First of Several Questions This same analysis is required for all financial service products. So let's go beyond rate, because that's just the starting point. The next step is to calculate the effective rate, so you know the actual cost. Then the most important question is, "What is the real cost to my business if I don't optimize my cash flow?" This answer comes from your cost/benefit analysis; an analysis that projects an increase or decrease in bottom line profit after expenses, including cost of funds. It shows the gain or loss from more immediately available cash; which you can use to meet payroll expense and taxes, get prompt payment discounts, bid on new contracts, protect your credit rating, and launch new products or new marketing campaigns. In other words continue to grow your business, even in a tough economy. A good financial vehicle for optimizing your cash flow is factoring, which is the process of selling your outstanding invoices. Factoring provides two strong benefits. First, you'll get your cash within 24-48 hours. Instead of waiting 30-60-90 days. And second, this is not a bank credit product so there are no interest payments. Factors work with emerging firms, that aren't yet attractive to traditional lenders, like banks. Plus, factors don't routinely impose tight credit line caps like lenders. Calculating Effective Rate Here are the questions to ask in addition to base rate when you meet with a factor: Does the factor require term limits or volume requirements? Can you get better pricing if you can commit to a specified timeframe or minimum volumes? Does the factor require that you factor all of your invoices? Can invoices age prior to factoring, which reduces your discount rate? Does the factor pro-rate fees to reflect faster payments from your customer? Or do you pay one fee with a 30-day minimum even if your customer pays within 10 days or two weeks? Does the factor use batch accounting or individual invoice accounting? How are non-factored receipts handled? Do transaction fees stop accruing immediately when your customer pays the invoice? Or after a check clearance delay? Do your reserve payments get released immediately or on a monthly basis? Does the factor require invoice repurchase after 60 days or 120 days? Does the factor require a personal guarantee? Or is this unnecessary? Is the program full recourse? Or non-recourse? And remember to complete your cost/benefit analysis using this effective rate for your cost of funds expense, so you can quantify the impact on your long-term growth. The Good News - Factors Are Competing For Your Business It seems like wherever you turn, there's a factor touting its service. Many factors are vying for the same business-yours. So you have the luxury of a buyers' market. Factoring is common in Europe and Asia, and becoming more popular in the U.S. Many types of firms sell their invoices. Companies like consulting or advertising agencies, temporary staffing, manufacturers, printers, hotel resorts, etc. Any firm with front end labor or material expense that could use immediate cash to cover high fixed costs and support new business. Here's An Easy Way to Evaluate a Factor's Proposal If you're like most business people, then time is a precious commodity. A consulting firm like Capital Consulting Group can help you evaluate a variety of proposals, and negotiate the best deal to support your long-term growth. We work with a stable of factors, and translate proposals into apples-to-apples comparisons that are easy for you to evaluate. My job is to save you time, so you can focus on what you do best. Grow your business. Phyllis Brown is a principal and cash flow strategist at Capital Consulting Group, New York, N.Y.