Factoring Invoices. How To Get Cash Without Borrowing
The Facts on Factoring:
How to Increase Cash Flow Without Borrowing
By Fred Coutts, CPA, CMA
Cash flow is one of the main reasons businesses fail. At one time or another,
every business, even successful ones, have experienced poor cash flow.
Cash flow does not have to be a problem any more. Do not be fooled -- banks are not the
only places you can get funding. Other solutions are available and you do not have to borrow.
What is Factoring?
One solution is called factoring. Factoring is the process of selling
accounts receivable to an investor rather than waiting to collect the money
from the customer.
Oh, the Irony…
Factoring has an ironic distinction: It is the financial backbone of
many of
factoring is not taught in business colleges, is seldom mentioned in business
plans and is relatively unknown to the majority of American business people.
Yet it is a financial process that frees up billions of dollars every year,
enabling thousands of businesses to grow and prosper.
Factoring has been around for thousands of years. Factors are investors who
pay cash for the right to receive the future payments on your invoices.
An unpaid receivable or invoice has value. It is a debt your
customer has agreed to pay in the near future.
Factoring Principals
Although factoring deals exclusively with business-to-business transactions,
a large percentage of the retail business uses a factoring principal. MasterCard, Visa,
and American Express all use a form of factoring in their retail transactions.
Using the purest definition of the word, these large consumer finance companies are really just large factors of consumer paper.
Think about it: You make a purchase at Sears and charge it to your MasterCard.
The store gets paid almost immediately, even though you
do not make payment until you are ready. For this service, the credit card company
charges Sears a fee (typical fees range from two to four percent of the sale).
The Benefits
Factoring can offer many benefits to cash-hungry companies.
Rather than wait 30, 60, 90 days or longer for payment on a product or
service that has already been delivered, a business can factor (sell)
its receivables for cash at a small discount off the amount of the invoice.
Payroll, marketing efforts, and working capital are just a few
of the business needs that can be met with this instant cash.
Factoring provides the means for a manufacturer to replenish
inventory and make more products to sell: There is no longer a need
to wait for earlier sales to be paid. Factoring is not just a cash
management tool for manufacturers: Almost any type of business
can benefit from factoring.
Generally, a business that extends credit will have 10 to 20 percent
of its annual sales tied up in accounts receivable at any given time.
Think for a moment about how much money is tied up in 60 days' worth of invoices:
You cannot pay the power bill or this week's payroll with a customer's invoice,
but you can sell that invoice for the cash to meet those obligations.
Factoring is a fast and easy process. The factor buys the invoice at a
discount, usually a few percentage points less than the face value of the invoice.
The Drawbacks
People consider the discount a small cost of doing business.
A four-percent discount for a 30-day invoice is common. Compared with the problem of not having cash when you need it to operate, the four-percent discount is negligible.
Look at the factor's discount as though your business had offered t
he customer a discount for paying cash. It works out the same.
Companies consider the discount the same way they treat
a sales price: It is simply the cost of generating cash flow, much like
discounting merchandise is the cost of generating sales.
Factoring is a cash flow tool used by a variety of businesses,
not just those who are small or struggling. Many companies factor to
reduce the overhead of their own accounting department. Others use factoring
to generate cash, which can be used to expand marketing efforts
and increase production.
Why Factoring Appeals to the Start-Up
Factoring is especially appealing to young and
rapidly growing companies. Since the process shortens
their business cycle, these businesses can grow faster. The ability to
make more products to sell while waiting for invoices to be paid
is largely eliminated. Such businesses usually net much more profit with
factoring than without, even when the discount is considered.
Factoring vs. Bank Loans
So, why not simply go over to the friendly banker for a loan
to alleviate cash flow problems? A loan can be difficult if not impossible to
receive, especially for a young, high-growth operation, because bankers are not
expected to decrease lending restrictions soon. The relationships between
businesses and their bankers are not as strong or as dependable as they used to be.
The impact of a loan is much different than that of the factoring
process on a business. A loan places a debt on your business balance sheet,
which costs you interest. By contrast, factoring puts money in the bank
without the creation of any obligation. Frequently, the factoring discount
will be less than the current loan interest rate.
Loans are largely dependent on the borrower's financial soundness,
whereas factoring is more interested in the soundness of the client's
customers and not the client's business itself. This is a real plus for new
businesses without established track records.
There are many situations where factoring can help a business
meet its cash flow needs. It provides a continuing source of
operating capital without incurring debt, which can result in growth
opportunities that dramatically increase the bottom line. Virtually any
business can benefit from factoring as part of its overall operating philosophy.
Every good businessperson must understand the concept and benefits of
factoring in order to operate as profitably as possible.
The following chart can help you understand the differences
between factoring and other sources of funding.
For more information on factoring and other non-traditional
ways to obtain funding,
contact Fred Coutts at
(206) 281-3153 or 1-888-942-6639
Fred@FredCoutts.com.
Please visit my website
at www.FredCoutts.com for more information on
powerful funding programs without going through a bank
Fred Coutts, CPA, CMA. All Rights Reserved.
posted by Factoring Invoices at 4:08 PM
