Factoring Financing: How to grow your business without debt or
loans
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 in Action: BSP, 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 (w/o 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.