By Marco Terry
What is factoring?
Accounts receivable financing, also known as factoring, is apowerful financial tool that has fueled the growth and successof a number of companies. Factoring enables companies tocapitalize on their unpaid receivables by selling them to afactoring company for immediate payment. With factoring,companies immediately get paid for their invoiced work from thefactoring finance company, while the factoring company waits tobe paid by the customers. Factoring strengthens a business' cashposition by shortening the time to get invoices paid to 48 hoursand providing the needed funds to meet current expenses andtarget new opportunities.
Factoring Benefits
As opposed to loans and lines of credit that require that theclient have tangible assets and strong financials, factoringrelies more heavily on the financial strength of the clients'customer. This is a critical feature, since many new and smallbusinesses do not meet the financial criteria of traditionallending institutions. However, many small businesses have aroster of financially strong customers that can be leveraged.Factoring empowers businesses to capitalize on their customerlist, and provides them with a tool to transform outstandingreceivables into immediate cash, without generating debt. SinceFactoring is not a loan, it is an ideal financial product forthe following:
o New and emerging businesses including small and homebusinesses, consultants and solo-preneurs. o Businesses withfinancially strong customers o Businesses that are preparing togrow significantly o Business with intangible assets (e.g.consultants) o Businesses that do not want to take a loan
An additional benefit of factoring is that the factor usuallyassumes part of the clients' credit risk for the customer. Thismeans that if the customer becomes financially insolvent due tobankruptcy and does not pay the invoice, the factor will assumethe loss. This is a critical service for small companies who maynot be able to afford the bankruptcy of a customer.
Costs
The costs of a factoring transaction - also known as thediscount - vary based on a number of variables such as thefinancial strength of the customer and the amount beingfactored. Generally, the discount is a percentage of theinvoice's face value that increases with time until the invoicegets paid. Small businesses, those that have between $20,000 and$300,000 in yearly revenues, can expect to pay a discount rateof about 2% for every ten (10) days that the invoice remainsunpaid. Businesses with factorable revenues in excess of$300,000 can expect lower discount rates.
Factoring in Action: BSP, Inc. Case Study
Business Services and Products, Inc. (BSP, Inc.) is a smallfictional company, which provides business consulting andequipment to local companies. It has $300,000 of annual revenuesand during the past year BSP Inc. has enjoyed significant salesgrowth. Although most business owners would be very happy tomanage such a company, Jane Sullivan, BSP Inc's president, isvery worried about her company's financial position.
Most of BSP Inc.'s customers are large companies with a goodreputation for always paying their invoices. However they alwaystake between 30 to 45 days to pay them. BSP Inc., however, needsto pay their employees every two weeks and their vendors everyfour weeks. This discrepancy between the time that customers paytheir bills and the time BSP Inc. needs to pay their employeesand vendors has created cash flow problems in the past.Furthermore, these cash flow problems have already caused Janeto delay payroll twice this year and have placed her trade(vendor) credit in jeopardy multiple times. This has also causedher to pass on a number of significant business opportunitiesbecause she was unsure of the company's financial ability tohire and pay for additional staffers. Unfortunately, BSP Inc.did not have a large enough financial cushion in the bank toafford paying employees while waiting for 45 days new clients topay their invoices.
The following table provides an overview of BSP, Inc's currentfinancial position.
Business Services and Products, Inc (w/o financing)
Yearly sales $300,000 Lost new sales opportunities Unknown TotalSales $300,000
Variable Costs(60% of Sales) $180,000 Fixed Costs(Rent, phones,etc) $20,000 Total Costs $200,000
Profit (Sales - Costs) $100,000
Although the company's prospects appear great, Jane may have tostall her company's growth until she builds a large enough cashcushion at the bank to finance her company's growth.
After careful consideration, Jane decided that a factoring lineof working capital could help strengthen her company's financialposition. Furthermore, factoring her invoices would enable BSPInc. to take on new customers and continue growing, knowing thatshe could capitalize on her slow paying customers. BSP Inc.'sfinancing agreement will provide the company with an advance of70% of her invoiced services. This means that the company canget 70% of the face value of the factored invoices within 24 to48 hours of submitting them to the factor. The remaining 30% ofthe funds, less the factoring fees, will be quickly rebated assoon as the customer pays their invoice.
This line of working capital strengthened the company'sfinancial position and bank account, enabling Jane to pay fornew employees to service new contracts. Jane also decided to usethe extra capital to pay her vendors early, obtaining quickpayment discounts and helping to reduce the cost of factoring.
BSP Inc. customers pay their invoices within 30 days of receipt.The discount (factoring fee) for these invoices is 6%. Everytime an invoice is paid, the factor rebates BSP Inc. theremaining 30% that was not advanced less the factoring fee. Thismeans that once the transaction is completed, the factor rebates24% (30% - 6%) to BSP Inc.
Thanks to the factoring line of working capital, Jane was alsoto secure an additional $120,000 worth of business, bringing herannual revenues to $420,000. The following table shows BSPInc.'s financial position a year after using factoring.
Business Services and Products (with factoring)
Existing Sales $300,000 New Sales $120,000 (factored) TotalSales $420,000 Variable Costs (60% of Sales) $252,000 FixedCosts (Rent, phones, etc.) $20,000 Cost of Factoring (6% of$120,000) $7,200 Total Costs $279,200 Net Profit (Sales -Costs) $140,800
As can be seen from the above table, factoring helped BSP Inc.increase profits substantially from $100,000 to $140,800 - a 40%increase. It placed BSP Inc. on a more stable financial footing,priming it for growth. Furthermore, the cost impact of factoringon the bottom line was minimal, as it was easily absorbed by theadditional business, showing that factoring was paid fordirectly by the growth.
Article Source: www.ArticlesBase.com
