Improve your cash flow with factoring

Do you operate a profitable business that would benefit from increased cash flow? Is too much of your working capital absorbed by 30-, 60- and 90-day terms to your customers? Would your business enjoy a "credit line" based on account receivables, requiring no other collateral, that you can draw on as needed and pay only for the funds you use? Would access to such a "credit line" enable you to better manage your business and finance its continued growth? If you answered yes to any of these questions, then your company should consider factoring, or accounts-receivable funding, as an alternative method of financing.

Essentially, factoring means "selling" your invoices (accounts receivable) to a factor-a financial company that immediately pays you some percentage (typically 60 to 80 percent) of the cash value of the invoice. The factor then becomes the receiver of the payment due. When your customer pays the amount due, the factor will pay you the remaining amount, less the agreed-upon fee-typically 3 to 5 percent of the value of the invoice.

Access to working capital Today, perhaps more than ever, banks are reluctant to finance contractors and subcontractors. As a result, the need for alternative financing is greater than ever. Finding sources to finance projects is difficult, but without financially stable contractors and subcontractors, a project would wind up dead in its tracks, causing delays and greater costs. Factoring is becoming the alternative-financing method of choice because it helps to shore up the financial stability of those who actually build the projects. In fact, banks are referring contractors and subcontractors to qualified factors in an effort to help those who have been, and may still be, their customers. Why? Because factoring can help the bank's customer survive financial setbacks and bankruptcies simply by financing their receivables. Accountants also may refer customers to factors because they can help improve their clients' cash flow for operating expenses.

Bid more work For example, by factoring receivables, a landscape contractor in Eastern Massachusetts was able to accept a contract to install the landscape and irrigation, and perform the maintenance on a new office complex. The contractor increased his cash flow, which allowed him to buy materials and supplies, pay his laborers and purchase the necessary equipment needed to finish what became his largest job ever.

But you don't have to be a contractor to qualify for alternative financing via factoring. Architects, engineers, surveyors and suppliers, who more than ever, are having difficulty obtaining financing, can increase their own cash flow to grow their business, complete their work on a project and use that success to obtain new work.

Factoring can help your business grow In another example, a commercial landscape contractor in Florida was a candidate for factoring. He inquired about points-the percentage he would be charged to factor-and how soon he would be able to receive the monies he needed. In this case, the contractor was eligible to receive an advance, under a no-term contract, with no credit risk, equivalent to 65 percent of a specific invoice totaling $25,000. Thus, he could receive $16,250 in cash wired directly to his bank account.

The contractor agreed to pay the factor a fee of 4 percent of the total invoice for the first 30 days as a fee on the $25,000. In other words, he would pay $1,000 to factor a $25,000 invoice for 1 month. He would receive the balance of the money-$8,750 less the $1,000 fee, for a total of $7,750-after receipt of the funds due toward payment of the invoice. He therefore received $16,250 immediately, plus $7,750 later, for a total of $24,000 for his $25,000 invoice.

The contractor was reluctant at first. He said he was operating in an extremely competitive market, his gross margin was 18 percent, and his annual overhead was $37,500. However, he felt that if he had "unlimited funds," he could double his business. "I would be doing $1 million in sales if I had unlimited funds. I'm turning away business now because I don't have the cash flow to handle it," he said.

This is a familiar scenario. However, many contractors wonder if doubling sales would also mean doubling overhead. The answer usually is "no." The extra $500,000 in sales might only cost him an additional $17,500 in overhead expenses because businesses usually do not need twice the space or twice the employees to double their volume. The economy of scale allows for an increase in net profit.

Without factoring, this contractor made $52,500 gross profit on $500,000 in sales. But, by factoring 100 percent of his receivables, he only had to factor $500,000 out of a projected $1 million in sales to generate a gross profit of $105,000. His annual cost for factoring was $20,000 (see table, above).

Factoring helped him grow his business by taking advantage of discounts offered by suppliers and early payment terms. Factoring also enabled him to accept larger projects that substantially increased his bottom line.

Keep in mind that factors do not buy retention. Retention is where the owner withholds a percentage of monies until a project meets the owner's satisfaction. What factors do is supply cash-cash to help you meet your payroll, tax and insurance needs, and to help you pay your suppliers and achieve greater discounts.

Factoring can be extremely convenient and fast. Factors can provide bank-to-bank wire transfers, do not require long-term contracts and will factor as many or as few invoices as you require. They don't need your financial statements and, in some cases, they can provide funding in 24 hours.

So, when your bank says "no," many times the factor will say "yes." To a factor, your receivables are as good as cash. If you're a business start-up, the factor may be able to help you, too.

Evaluate your company's needs Factoring is not for every business. You may already have adequate cash reserves available, or you may be better served by a traditional bank loan, asset-based lending or venture capital. Each form of capital generation has its positives and negatives, and you should carefully research each before you make a decision. However, factoring is a tool that can improve your business's cash flow almost immediately. Factors typically require a simple two-page application and can begin to provide cash assistance to a business within 7 to 10 working days.

Gary S. Goldman is president of Alternative Funding, Inc. (Sherborn, Mass.), which provides accounts-receivable funding for all industries including construction receivables, purchase-order financing, equipment leasing and financing, credit lines and asset-based loans. For more information, contact Mr. Goldman at (800) 305-0898.

Q. What type of receivables are acceptable? A. Just about any valid business-to-business invoice for services performed or product delivered.

Q. What is required before an invoice may be funded? A. Your customer must be creditworthy and your product or service must be completed, delivered and accepted by that customer.

Q. Does the factor bill on our letterhead or yours? A. You continue to bill normally. Checks may be made payable to you but mailed to the factor.

Q. What does it cost? A. Factors' fees vary. Typical fees for 30 days range from 3 to 5 points. Fees are lower for shorter time periods or for reduced advances.

Q. Are government receivables acceptable? A. Yes. Factors handle a considerable amount of government- or municipal-related receivables.

Q. Must I agree to finance a minimum volume of future receivables? A. No. Finance one invoice or as many as you need to meet your cash flow needs. Stop when you wish or continue as needed.

Q. What will my customers think? A. Of course, you can't absolutely control what your customers think. However, you should remind them that receivables-based financing is a well-established practice used by many businesses, large and small, to improve cash flow, support growth and increase profits. Many of your customers may use this service themselves and others have become familiar with it through other vendors. Portray the fact that you qualify for this unlimited "credit line" as a positive statement about the health and stability of your business.

Q. Can we qualify with a history of credit problems such as bankruptcy, IRS liens or judgements? A. Yes. That's another advantage of utilizing this service. Factors often make arrangements with the IRS or the courts.

Q. Can we qualify if we already have existing credit lines or SBA loans? A. Yes. Factors can complement and work in cooperation with your existing lenders.

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