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Your business is amassing an impressive list of clients and receivables are growing. Yet there are times when you need cash immediately, and 30 days net just doesn’t come soon enough. So where do you turn for financing? How about your own receivables?
Factoring–a method of asset-based financing in which receivables are purchased or used as collateral–can provide immediate cash. Although this process is nothing new, many entrepreneurs have never heard of it. Still, about $61.6 billion in receivables were factored in 1995 ($40 billion by banks), says Bruce Jones, deputy executive director of the Commercial Finance Association in New York City. Prevalent in the textile and garment industries for centuries, factoring is also providing cash flow to the service, publishing and frozen foods sectors, among others, says Jones.
Joseph LaPaglia, president of Cash Flow Funding of Virginia in Richmond, says businesses typically make use of factoring to provide cash flow for immediate working capital needs, such as making payroll, inventory purchases, etc. Factors can be subsidiaries of banks or independent financing firms. Typically, a factor will buy or advance 70%-80% of the money due on a receivable and in turn assess a finance charge or “discount” (LaPaglia suggests 4%-5% as a benchmark) on the total amount of the receivable. There are two basic types of factors: recourse factors, which will negotiate terms under which they can recover the money if a receivable is overdue; and nonrecourse factors (generally larger institutions), which will buy receivables outright and assume full responsibility for collection.
Many small businesses are good candidates for factoring because their credit history is not as important to a factor as the credit history of the customer paying the receivables, says LaPaglia. Medical billing businesses are especially attractive, because their clients are large insurance companies, whereas construction companies can pose a greater risk from a collection standpoint.
Dexter Bridgeman, president of Mentor Magazine in Ardsley, New York, advises that a business in need of cash also conduct its own credit check of a client before deciding to factor a particular receivable. Also, be sure that your company’s profit margin will allow a 4% benchmark. At one point, Bridgeman says, his four-year-old magazine factored approximately half of its invoices, which equated to about $20,000 in receivables per month. “But I learned not to factor every invoice,” he says, recalling the time an advertising agency took 120 days to pay. His recourse factor charged an extra 1% for every 10 days beyond 30 days that the receivable was due.
If you’re interested in financing via a factor, it can be as simple as asking your local bank officer or finding a factor in the Yellow Pages. For more information, contact the Commercial Finance Association at 212- 594-3490 or visit their Web site at www.cfa.com.