How to Use Factoring for Fast Cash
Factoring, as $80-billion-a-year industry, is generally not well understood by small business owners. Factoring is a financing method that can convert your actualized sales into dollars. Your receivables act as collateral for a short-term loan.
What factoring can do for you
If you’re selling on the net 30-, 60- or 90-day terms, you’re in effect acting as a banker, helping your customers finance their purchases from you on an interest-free basis. In the meantime, you must wait to collect the cash you need to pay your vendors or other parties to whom you owe money. Some of this “borrowing” can cost you in interest charges.
Factoring allows you to sell your receivables. There’s no limit on the extent to which you can use this financing method – you can convert some or all of your receivables to cash, depending on your cash flow needs. For example, you can sell receivables one month, but not the next.
Factoring works best for the following profiles:
- A company that’s been in business only a short while, and therefore may have difficulty obtaining traditional financing.
- A company with a large payroll and backlogged receivables.
Bonus:To the extent you can obtain money through factoring to pay off your obligations, you improve your credit evaluation. This, in time, can help you obtain traditional financing at favorable interest rates. In addition, factoring does not appear on your balance sheet as a bank loan.
What it costs
You won’t receive 100% of your receivables – the amount you can obtain from a factoring company depends on certain variables:
Typically, factoring provides you with immediate cash for 80% or 90% of the amount of the invoices submitted as collateral. When the factor collects on the receivable, it retains the amount it advanced to you, plus a fee, and forwards the balance collected to you. The factoring fee (also called an origination fee) generally runs 2% to 4% of the loan balance. It is a flat charge based on the gross amount of invoices. In addition, you’ll pay an interest charge on the funds advanced to you. (Some factors charge a factoring fee for each 30-day period in lieu of interest charges, an arrangement that may cost more than interest itself.)
Example: You have a $20,000 invoice with net 30-day terms. The factor agrees to advance you 80% and charge a 2% fee, plus a 12% APR. If the customer pays your invoice within the 30-day period, you’ll receive a total of $19,240 [$16,000 advance ($20,000 x 80%), plus $4,000 balance minus $400 factoring fee and $160 (1% interest on $16,000)]. In a sense, you’ve paid 5.2% (fee plus interest) for one month of borrowing.
Factoring can help you collect more of your money because the factor is responsible for collections. You retain all billing functions, but collections essentially shift to the factor, which as collections resources at its disposal.
Getting started
Before you use a factor, talk with your financial advisor to see if this type of financing makes sense for you. But once you decide to go ahead, the process is relatively easy. Unlike traditional loan applications where you need to supply reams of information, factoring is rather straightforward. You send the factor your invoices, arrange terms and start the process. Usually, you can obtain your money within 24 to 48 hours.
Look for factors that specialize in your industry (e.g. apparel, trucking). You can easily find a number of factors that fit the bill through an Internet search.
