Orange County attorney article review: Many young, fast growing businesses utilize this concept of factoring. Factoring provides for a manufacturer to replenish inventory and make more products to sell without waiting for earlier sales to be paid. This article goes further into depth about this fast and easy process.
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Factoring. Cash Without Borrowing
by Fred Coutts
Cash flow is one of the main reasons businesses fail. At one time or another,
every business, even successful ones, have experienced poor cash flow. Cash flow
does not have to be a problem any more. Do not be fooled -- banks are not the
only places you can get funding. Other solutions are available and you do not
have to borrow.
What is Factoring?
One solution is called factoring. Factoring is the process of selling accounts
receivable to an investor rather than waiting to collect the money from the
customer.
Oh, the Irony…
Factoring has an ironic distinction: It is the financial backbone of many of
America's most successful businesses. Why is this ironic? Because factoring is
not taught in business colleges, is seldom mentioned in business plans and is
relatively unknown to the majority of American business people. Yet it is a
financial process that frees up billions of dollars every year, enabling
thousands of businesses to grow and prosper.
Factoring has been around for thousands of years. Factors are investors who pay
cash for the right to receive the future payments on your invoices.
An unpaid receivable or invoice has value. It is a debt your customer has agreed
to pay in the near future.
Factoring Principals
Although factoring deals exclusively with business-to-business transactions, a
large percentage of the retail business uses a factoring principal. MasterCard,
Visa, and American Express all use a form of factoring in their retail
transactions. Using the purest definition of the word, these large consumer
finance companies are really just large factors of consumer paper.
Think about it: You make a purchase at Sears and charge it to your MasterCard.
The store gets paid almost immediately, even though you do not make payment
until you are ready. For this service, the credit card company charges Sears a
fee (typical fees range from two to four percent of the sale).
The Benefits
Factoring can offer many benefits to cash-hungry companies. Rather than wait 30,
60, 90 days or longer for payment on a product or service that has already been
delivered, a business can factor (sell) its receivables for cash at a small
discount off the amount of the invoice.
Payroll, marketing efforts, and working capital are just a few of the business
needs that can be met with this instant cash.
Factoring provides the means for a manufacturer to replenish inventory and make
more products to sell: There is no longer a need to wait for earlier sales to be
paid. Factoring is not just a cash management tool for manufacturers: Almost any
type of business can benefit from factoring.
Generally, a business that extends credit will have 10 to 20 percent of its
annual sales tied up in accounts receivable at any given time. Think for a
moment about how much money is tied up in 60 days' worth of invoices: You cannot
pay the power bill or this week's payroll with a customer's invoice, but you can
sell that invoice for the cash to meet those obligations.
Factoring is a fast and easy process. The factor buys the invoice at a discount,
usually a few percentage points less than the face value of the invoice.
The Drawbacks
People consider the discount a small cost of doing business. A four-percent
discount for a 30-day invoice is common. Compared with the problem of not having
cash when you need it to operate, the four-percent discount is negligible. Look
at the factor's discount as though your business had offered the customer a
discount for paying cash. It works out the same.
Companies consider the discount the same way they treat a sales price: It is
simply the cost of generating cash flow, much like discounting merchandise is
the cost of generating sales.
Factoring is a cash flow tool used by a variety of businesses, not just those
who are small or struggling. Many companies factor to reduce the overhead of
their own accounting department. Others use factoring to generate cash, which
can be used to expand marketing efforts and increase production.
Why Factoring Appeals to the Start-Up
Factoring is especially appealing to young and rapidly growing companies. Since
the process shortens their business cycle, these businesses can grow faster. The
ability to make more products to sell while waiting for invoices to be paid is
largely eliminated. Such businesses usually net much more profit with factoring
than without, even when the discount is considered.
Insurance Research Council National Survey of auto injury claims
Factoring vs. Bank Loans
So, why not simply go over to the friendly banker for a loan to alleviate cash
flow problems? A loan can be difficult if not impossible to receive, especially
for a young, high-growth operation, because bankers are not expected to decrease
lending restrictions soon. The relationships between businesses and their
bankers are not as strong or as dependable as they used to be.
The impact of a loan is much different than that of the factoring process on a
business. A loan places a debt on your business balance sheet, which costs you
interest. By contrast, factoring puts money in the bank without the creation of
any obligation. Frequently, the factoring discount will be less than the current
loan interest rate.
Loans are largely dependent on the borrower's financial soundness, whereas
factoring is more interested in the soundness of the client's customers and not
the client's business itself. This is a real plus for new businesses without
established track records.
There are many situations where factoring can help a business meet its cash flow
needs. It provides a continuing source of operating capital without incurring
debt, which can result in growth opportunities that dramatically increase the
bottom line. Virtually any business can benefit from factoring as part of its
overall operating philosophy.
Every good businessperson must understand the concept and benefits of factoring
in order to operate as profitably as possible. The following chart can help you
understand the differences between factoring and other sources of funding.
For more information on factoring and other non-traditional ways to obtain
funding, contact Fred Coutts at (206) 364-9613 or Fred@FredCoutts.com.
Please visit my website at www.FredCoutts.com for more information on powerful
funding programs without going through a bank
© Fred Coutts, CPA, CMA. All Rights Reserved.
Since 1980, Fred Coutts has been crafting powerful cash flow solutions for
businesses and individuals alike, from entrepreneurs to "Fortune 500"
companies. He has built a solid foundation of financial and operational
experience through many executive roles, including those as CFO and Controller.
Fred is well versed and experienced in finance, accounting, and business
operations.
Over the years Fred has developed relationships with funding connections
nationwide, both traditional and non-traditional sources to help you meet your
cash flow needs.
Professional Certifications:
---Certified in Public Accounting(CPA)
---Certified in Management Accounting(CMA)
All Rights Reserved.
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