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by: Marco Terry
What is factoring?
Accounts receivable financing, also known as factoring, is a
powerful financial tool that has fueled the growth and success of a
number of companies.
Factoring enables companies to capitalize on their unpaid
receivables by selling them to a factoring company for immediate
payment. With factoring, companies
immediately get paid for their invoiced work from the factoring
finance company, while the factoring company waits to be paid by the
customers. Factoring
strengthens a business' cash position by shortening the time to get
invoices paid to 48 hours and providing the needed funds to meet
current expenses and
target new opportunities.
Factoring Benefits
As opposed to loans and lines of credit that require that the client
have tangible assets and strong financials, factoring relies more
heavily on the
financial strength of the clients' customer. This is a critical
feature,since many new and small businesses do not meet the
financial criteria of traditional
lending institutions. However, many small businesses have a roster
of financially strong customers that can be leveraged. Factoring
empowers businesses to
capitalize on their customer list, and provides them with a tool to
transform outstanding receivables into immediate cash, without
generating debt. Since
Factoring is not a loan, it is an ideal financial product for the
following:
o New and emerging businesses including small and home businesses,
consultants and solo-preneurs.
o Businesses with financially strong customers
o Businesses that are preparing to grow significantly
o Business with intangible assets (e.g. consultants)
o Businesses that do not want to take a loan
An additional benefit of factoring is that the factor usually
assumes part of the clients' credit risk for the customer. This
means that if the customer
becomes financially insolvent due to bankruptcy and does not pay the
invoice, the factor will assume the loss. This is a critical service
for small companies
who may not be able to afford the bankruptcy of a customer.
Costs
The costs of a factoring transaction - also known as the discount -
vary based on a number of variables such as the financial strength
of the customer and
the amount being factored. Generally, the discount is a percentage
of the invoice's face value that increases with time until the
invoice gets paid. Small
businesses, those that have between $20,000 and $300,000 in yearly
revenues, can expect to pay a discount rate of about 2% for every
ten (10) days that the
invoice remains unpaid. Businesses with factorable revenues in
excess of $300,000 can expect lower discount rates.
Factoring at Work: Business Services and Products, Inc. Case Study
Business Services and Products, Inc. (BSP, Inc.) is a small
fictional company, which provides business consulting and equipment
to local companies. It has
$300,000 of annual revenues and during the past year BSP Inc. has
enjoyed significant sales growth. Although most business owners
would be very happy to
manage such a company, Jane Sullivan, BSP Inc's president, is very
worried about her company's financial position.
Most of BSP Inc.'s customers are large companies with a good
reputation for always paying their invoices. However they always
take between 30 to 45 days to
pay them. BSP Inc., however, needs to pay their employees every two
weeks and their vendors every four weeks. This discrepancy between
the time that
customers pay their bills and the time BSP Inc. needs to pay their
employees and vendors has created cash flow problems in the past.
Furthermore, these cash
flow problems have already caused Jane to delay payroll twice this
year and have placed her trade (vendor) credit in jeopardy multiple
times. This has also
caused her to pass on a number of significant business opportunities
because she was unsure of the company's financial ability to hire
and pay for additional
staffers. Unfortunately, BSP Inc. did not have a large enough
financial cushion in the bank to afford paying employees while
waiting for 45 days new clients
to pay their invoices.
The following table provides an overview of BSP, Inc's current
financial position.
Business Services and Products, Inc (without financing)
Yearly sales: $300,000
Lost new sales opportunities: Unknown
Total Sales: $300,000
Variable Costs (60% of Sales): $180,000
Fixed Costs (Rent, phones, etc): $20,000
Total Costs: $200,000
Profit (Sales - Costs): $100,000
Although the company's prospects appear great, Jane may have to
stall her company's growth until she builds a large enough cash
cushion at the bank to
finance her company's growth. After careful consideration, Jane
decided that a factoring line of working capital could help
strengthen her company's
financial position. Furthermore, factoring her invoices would enable
BSP Inc. to take on new customers and continue growing, knowing that
she could
capitalize on her slow paying customers. BSP Inc.'s financing
agreement will provide the company with an advance of 70% of her
invoiced services. This means
that the company can get 70% of the face value of the factored
invoices within 24 to 48 hours of submitting them to the factor. The
remaining 30% of the
funds, less the factoring fees, will be quickly rebated as soon as
the customer pays their invoice.This line of working capital
strengthened the company's
financial position and bank account, enabling Jane to pay for new
employees to service new contracts. Jane also decided to use the
extra capital to pay her
vendors early, obtaining quick payment discounts and helping to
reduce the cost of factoring.
BSP Inc. customers pay their invoices within 30 days of receipt. The
discount (factoring fee) for these invoices is 6%. Every time an
invoice is paid, the
factor rebates BSP Inc. the remaining 30% that was not advanced less
the factoring fee. This means that once the transaction is
completed, the factor rebates
24% (30% - 6%) to BSP Inc. Thanks to the factoring line of working
capital, Jane was also to secure an additional $120,000 worth of
business, bringing her
annual revenues to $420,000.
The following table shows BSP Inc.'s financial position a year after
using factoring.
Business Services and Products (with factoring)
Existing Sales: $300,000
New Sales: $120,000 (factored)
Total Sales: $420,000
Variable Costs (60% of Sales): $252,000
Fixed Costs (Rent, phones, etc.): $20,000
Cost of Factoring (6% of $120,000): $7,200
Total Costs: $279,200
Net Profit (Sales - Costs): $140,800
As can be seen from the above table, factoring helped BSP Inc.
increase profits substantially from $100,000 to $140,800 - a 40%
increase. It placed BSP Inc.
on a more stable financial footing, priming it for growth.
Furthermore, the cost impact of factoring on the bottom line was
minimal, as it was easily
absorbed by the additional business, showing that factoring was paid
for directly by the growth.
About the author:
About Commercial Capital, LLC and Marco Terry
Commercial Capital, LLC is a leading commercial finance company that
specializes in providing working capital through factoring to small
businesses. For more information or a free consultation, please
visit our web sites at http://www.ccapital.net or
http://factoring.qlfs.com or call us at (786) 206 4722.
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