Factoring Accounts Receivables

What to look for when choosing an accounts receivables program

For many businesses, they have periods in their business cycle where cash flow becomes hard to manage and they look for alternatives. One of the alternatives that many consider is an Accounts Receivable Financing Program.

Commonly referred to as Asset-Based Lending or Factoring, there is a wide diversity of these types of programs and what types of businesses would best benefit by using what type of program.

In looking at any of these options, the prospective borrower should ask themselves three main questions:

• Why do I need this type of program?
• What will it cost my business?
• How easy is it to use?

The first and most important question is why do I need to look at this option? Would a conventional line of credit help me through my cash crunch? The reasons that a business would use this type of financing typically fall into four main categories:

• Your business is less than two years old. Most banks will only offer traditional lines of credit to businesses that are more than two years old and have a demonstrated track record of running a business. Even if you have owned businesses in the past and successfully run companies, you still fall under the two year old rule.
• Your company is growing too fast. High growth, while good for a business owner, is viewed as bad by banks for traditional lines of credits. In a growth mode, the balance sheet of the growing company does not fit the loan guidelines for most banks. At the very time that you need more cash availability, the banks want to reduce their exposure because of growth.
• Your company does not fit the traditional lending requirements of a bank. Many industries such as printing, trucking, textiles, consulting and staffing do not fit traditional bank lending parameters. By nature, some of these businesses carry high levels of debt for their machinery and equipment to operate. While it is necessary to have this high level of debt, it prevents them from being able to borrow the money necessary to run their businesses. They are considered too leveraged. Others, such as staffing and consulting do not have any hard assets to secure the loan. Their main resource is personnel and billable hours and many banks are uncomfortable lending against these types of assets. Lastly, in the current economic environment, many companies are paying slower. While net 30 used to mean that you got paid within 45 days; now net 30 usually means over 60 days until you get paid. While the balance sheet looks good, there is usually not enough cash to pay your weekly bills.
• Your company is in financial difficulty. While these types of lending can sometimes accelerate the problem, they can often help a company out of a bad situation. If you have identified the problem and have a plan in place to fix the problem within a specified period of time, accelerating cash flow can be of benefit.

With all of these scenarios, it is important to only use this type of financing for short term expenses (less than one year). It is never good to finance long term debt with short term solutions. Also, this type of lending is typically used for a period of several months or longer. If a company needs a one-time quick fix of cash, there are better options available for companies.

The next question to ask is how much does this type of financing cost?

The important question regarding cost is to compare the cost of the program to the benefit that the business will receive. It may make your life easier, but if it costs more than increases profit, it is a bad solution.

The pricing structure for this type of lending is very difficult to determine the actual annual cost. Most pricing structures are a combination of discount fees, interest rates and fees. A typical pricing structure would include an upfront discount fee to finance the account. After a certain number of days, the fee either goes to a higher discount fee and continues to increase in price for the number of days outstanding or it starts accruing interest at a rate over prime. Lastly, there are usually fees associated with these types of programs which can include: annual line fees, wiring fees, mailing fees and audit fees. It is usually difficult to track all of these costs to get a true picture of the expense of this type of financing.

It is best to have a fixed, up-front cost structure that you can budget into your pricing and to know that no additional fees can be added to your cost. Credit cards are the most common example of this type of pricing structure. If you accept credit cards for payment, you know the fixed fee that will be charged and you can calculate that fee into your pricing structure. If you do not know the final cost of your financing program, you may start to lose money on your work.

The last question to ask is how easy is this type of financing to use?

Part of the cost question that we discussed above includes how much time does a program like this save me and my company. If you spend large amounts of time tracking everything to manage the program and to comply with regulations, you may find yourself again losing money.

Some of the things to consider in terms of ease of use include:

• What is the daily process to receive financing. Do I have to contact my customers for each invoice and have them sign documentation? How is information communicated back to me to keep my records accurately?
• What sort of reporting does the provider give and at what frequency to allow me to stay up to date on my financial information?
• How long do I have to use the program and at what level? What are the exit fees and requirements?
• Do I have to change my banking relationship from my existing bank?

Once you have determined why you need the program, what the total cost of the program is and how easy each option is to use, you will be well on your way to helping your company grow!