When you sell your accounts receivable to a financial institution, financing costs can exceed 20%, but that’s upper hand than no financing at all

by Tom Taulli

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The breakdown in the credit markets clearly isn’t limited to the financial activity itself (BusinessWeek, 10/02/08), and some businesses (BusinessWeek.com, 9/26/08), particularly owners with bad credit, unproven ventures, or companies tied to troubled industries, are having difficulty. As a decision, there is heightened private interest in alternative sources of financing, which can range from peer-to-peer loans (BusinessWeek.com, 12/21/07) to businesses securing money from their own customers (BusinessWeek.com, 5/5/08).

Another option I’ve been acquirement a number of questions about is a type of internal sin financing known as factoring. Simply put, this is at the time a company sells its accounts receivable to a pecuniary institution or investor known as a factor. While factoring has been around in quest of hundreds of years, the traditional banking industry considers it a backwater for struggling companies—mainly because financing costs on factoring can easily exceed 20% of the value of the receivables. And let’s face it, banks usually focus on mature companies that have trustworthy asset bases.

To understand factoring, weigh this example: Suppose you have $100,000 in receivables. A agent inclination advance funds to you at a certain percentage of the total purport, frequently ranging from 75% to 80% (this is called the retention), based on a variety of factors, including:

• The quality of the receivables. If the customers include biggies like Wal-Mart (WMT), then the percentage will be higher.

• Historical average outstanding period of list. If the receivables are often paid late (answer by 15 to 30 days), then this could mean a lower reserve.

The factor has procedures to ledger (account for the transactions) and administer the accounts receivable as commendably conduct credit assessments and feel collections (BusinessWeek.com, 7/11/08). Once the receivables are paid on the farther side, you will get the difference betwixt the face footing and the reserve. However, for this service, a factor will reach a fee of 2% to 5% of the first 30 days the invoice is outstanding. Typically, there will be a 1/8th% to 1/15% fief notwithstanding each additional day. Yes, the financing can get expensive fairly quickly.

But in that place are benefits. First of totally, you be possible to receive money in about five to 10 days. In some cases, it could be within common to two days. This can be critical when your company is in a crunch. Additionally, in that place is no requirement for your company to have a credit check. That’s for the cause that factors normally only be lacking to evaluate the ability of your customers to pay.

Still, you need to exist mindful of the fine print. For example, a middleman may want purchaser checks made payable to itself. Needless to utter, this can scare your customers. The good news is you have power to negotiate this away, according to factoring expert Marty Nason, a partner with B2B CFO, a firm that provides part-time main financial officer services. Nason also says you should avoid having to submit high minimum levels of receivables. The minimums can easily twitch at $75,000 to $100,000 per month. In other words, he recommends you don’t factor too plenteous.

Where transact you provide factors? The factoring industry itself is fragmented and made up of many players, frequent people of which may want onerous terms. Thus, I would consider established entities, such since Liquid Capital.

Another approach is to application an online marketplace, such as The Receivables Exchange, where you can post your receivables on a private Web site and have financial institutions bid on them. As a result, you are well-adapted to get more competitive financing rates (in that place are also no minimum post amounts). The Receivables Exchange says it has access to about $8 billion, though your company must meet the following requirements: two years of operational history, $1.5 million in annual revenue, and no tax liens.

Yes, factoring is far from perfect. And admitting that your own customers are having problems paying you, the financing costs have power to have existence significative. However, in the tide frugality, it’s certainly getting tougher to secure capital from traditional lenders. Factoring should allow your company to get cash fairly quickly.

For more on other forms of alternative financing, check abroad the stories in the related items box on the upper-right side of this story.