Factoring Financing: How to grow your business without debt or loans
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.
Many people who wish to start their own business need an
injection of financial capital at the beginning of a business; the main
source of funding for entrepreneurs is business loans.
Let's take a look at what you should expect if you plan to
apply for one.
First of all, you should know that most lenders have their
doubts when it comes to lending money to a first-time business owner.
You're considered a high business risk at this point, and you should go in
to your loan negotiations armed with a few advantages. Of course, the
ideal option is to run your business for a few years, even just out of
your home, and turn a good profit before approaching a bank for a loan.
That shows that you have the ability to make money and
that your business won't flop before the Open sign shows up on the door.
But if this isn't possible, if you need the cash before you can begin at
all, then chances are you will need to offer some type of collateral.
Collateral can be anything from your car to your home and everything in
between. Depending on the size of the loan, you may require some pretty
hard assets for collateral. The lender is not interested in whether or not
your business will make money, aside from the extent that will allow you
to pay them back on time. They simply don't want to lose out on the loan,
and so you'll have to find some way to back yourself up.
Backing up your loan with assets, if you have them, is a
good route - provided you have enough confidence in your financial
situation to ensure you are not going to lose your collateral. If you
don't have enough assets to stand in for your loan, another option is to
find a cosigner. Chances are you won't get as much cash as you would if
you had the assets. But having someone with good credit who is willing to
sign onto your loan and promise to pay if you don't can be the factor that
gets you through the door. This is a good way for friends and family who
believe in your business to help you get it off the ground, even if they
don't have the money to loan you up front.
When it's time to borrow, do some comparison-shopping
among banks and credit associations, and don't stop until you find the
lowest interest rate possible. You're already gambling a lot here-
minimize the amount you will have to pay back by doing your homework and
choosing the company that offers you the best deal. If you can't get
enough to cover your beginning business expenses, consider borrowing part
of the cash from a friend or relative if you can, or even asking for
investors, such as customers who believe in your business, to help out.
Don't accept a high-rate, high-risk business loan just because it offers
you the biggest amount.
The small business loan: The first step in a long chain of
financial events. If you take the right step, it could be your leap into
the business world.
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