Quick Cash: Factoring Receivables

In the business world, managing capital is vital to success. While providing clients with payment terms of 30-90 days is often necessary to remain competitive, this practice can increase a firm's accounts receivable, hindering cash flow and impacting business decisions. Having money available enables a firm to take advantage of vendor discounts and respond to seasonal demands, allows timely payment of payroll and taxes, and provides resources for production, distribution, sales, and expansion. However, when cash outflow exceeds payments received on a continuing basis, a cash flow problem can arise and result in a need for financing.

When working capital is needed immediately, factoring the firm's accounts receivable may be a better solution than a short-term bank loan. Factoring converts accounts receivables into immediate cash through the sale of invoices at a discount to a factor or third-party financial agent, such as American Prudential Capital.

"Factoring is the appropriate financial instrument at various stages in the life of a company," said Brenda Standlee, president of American Prudential. "For emerging businesses, factoring enables the business to establish itself without loss of equity and without incurring long-term debt. Mid-life businesses use factoring to take on new opportunities like acquisitions or large one-time contracts. For the seasoned business, factoring is used to fund exit strategies for retiring entrepreneurs."

Factoring is a technique used by companies to manage an uneven cash flow from accounts receivable and provide consistent financing. The selling company obtains payment immediately, avoiding the collection difficulties from no-pay and slow-pay clients. Since the transaction is not a loan, the selling company incurs no debt, credit ratings remain unaffected, the balance sheet and income statement appear more attractive, and the company operates in a healthier financial state. Furthermore, the factor's rate is based on a company's creditworthiness as opposed to its financial risk.

The savvy business owner knows to build relationships with both his banker and his factor so as to utilize each most effectively. Typically, companies use a factor when other financial resources are unavailable. Factoring companies vary on the level and number of services provided. Factors do not typically assume the customer's credit risk and accounts are most commonly purchased on a recourse basis. The factor may perform collections on the accounts receivable and offer related reporting services. Finally, the factor may provide expertise related to disputes, returns and adjustments.

Corporations of every size and in every business can benefit from factoring receivables in order to finance business growth and meet financial responsibilities. Firms in the medical, technology, construction, trucking, fashion, telecommunications, and entertainment industries consistently use factoring as a means to obtain cash to sustain and expand business operations. New ventures, companies experiencing a high growth phase, and those in ownership transition are also good candidates for factoring receivables.

The factoring fee is usually a discount off the face value of the receivables and can be offset by negotiating discounts with vendors for early payments.

In the life cycle of a company, factoring is one tool that should not be overlooked.