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An Idea to Factor In
When You Need Funds |
For many growing companies, a large percentage of working capital is tied up in accounts receivable. Some businesses that extend credit have as much as 20 percent of their annual sales outstanding. Of course, receivables help to grow your company's balance sheet but they're not much use when you need money.
One way to get a quick infusion of cash is to turn to a little-known service called "factoring." With this
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Count the Benefits |
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o An immediate cash flow increase.
o The ability to meet your bills and demands. You no longer have to wait for invoices to be paid to increase production or purchase inventory.
o The possibility of reducing or abolishing your accounts receivable department. This savings could more than offset the fee charged by the factor firm.
o The potential to eliminate the risks and expenses of bad debt. (However, some factoring relationships are established with only partial recourse.) |
option, your company sells its accounts receivable to a bank or financing firm and it assumes the risk of collection.
The best part: Your company gets money almost immediately, within 24 hours in some cases. Compare this with the 30 days or longer that your company usually waits for customers to pay.
Factoring is not a new financing technique. For those of you who are financial history buffs, it's been around since the Mesopotamians came up with the concept 4,000 years ago. The first widespread, documented use of it in North America occurred in the American colonies down south before the revolution.
In its modern formulation, it works basically the same way as accepting a credit card. Your company receives the money right away and the factoring company waits for payment.
Typically, the factoring company pays your company an advance of between 70 percent and 90 percent of the face value of the invoices. When the customers pay, the factoring company takes out its fee and pays your company the balance.
The fees range from three percent to five percent of the invoices, based on sales volume, the creditworthiness of your customers and the average invoice size. So factoring is more expensive than most other forms of finance. But, your company saves by not having to do the credit functions itself and if the money you get brings in new business, it can be fairly easy to justify the costs.
Moreover, you aren't adding debt or diluting equity, and as your company's working capital builds up, it can reduce the amount it factors, carrying more of its own accounts and eventually becoming completely self-financing.
The process is especially appealing to young and rapidly growing companies since it shortens the cash cycle.
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