Article Contributed by Andrew Cravenho
Start-ups may be large or small, members of the service industry or manufacturers; however, there are common elements in all types of businesses.
First of all, there have to be sales. For service industries such as the medical field, it would be the number of patients seen over the course of the day. For manufacturers it could be the number of widgets ordered and produced.
Also common to all start-ups is the decision to grant or to not grant credit to those purchasing products or services. For example, most doctors and hospitals bill you for services if it is a major bill, such as surgery. Yet the same doctor may have an office policy requiring payment at the end of a regular visit. Sub-contractors, such as roofers and carpenters, generally bill the contractor and wait to be paid.
Start-ups must budget and calculate whether they have enough funds to pay their own bills and debts. New businesses that cannot wait to collect their accounts receivable often turn to banks for help. When you’re trying to keep a company afloat, cash is king.
What is factoring?
“Factoring” is the purchasing of outstanding receivables (debts owed to businesses). The term factoring often has negative connotations for bankers. Not because it is bad, but because of the way factoring has been used. Factoring usually is not offered through banks, but by outside companies seeking higher profits.
Some industries routinely turn to factoring: for example, your department store credit card bill probably isn’t generated at the department store’s home office. It’s likely processed by a third party, such as Household Finance Corp. or GE Money Bank. The retailer saves the cost of hiring people to collect the accounts and gets its cash quickly.
Factoring companies profit in two basic ways. First, they discount the amount of receivables by a certain percentage. For example, if $10,000 is owed to the company then that amount might be discounted to $9,000. So for the $10,000 in money owed to your business, the factoring company will only give you $9,000.Then the same company will charge your firm interest until that amount is paid.
Accounts Receivable Financing vs. Factoring
A few banks have started a new type of accounts receivable financing to help start-ups manage their accounts receivable and provide for more efficient billing. Receivables financing is traditional debt financing using a company’s receivables to secure the debt. In receivables financing, the receivables are a source of collateral for obtaining financing on typically a short-term basis.
Factoring and receivables financing differ in that factoring involves transferring the ownership of the receivables, while in financing, receivables are simply pledged as collateral. In the latter, the business is still responsible for collecting from its customers. However, if receivables are factored with recourse, the business still has full responsibility for collection.
What kind of terms are available when factoring?
In both factoring and receivables financing, certain receivables carry greater value for financing. The age of the receivable and creditworthiness of the customer are considerations. For example, a bank may accept only receivables less than 90 days past due.
Usually, lenders will not lend 100 percent of the receivables; instead they discount them for possible bad debts. Discount fees are applied based on these considerations. Discount fees of 2 percent to 5 percent on lower risk and 8 percent or more for higher risk are typical. Discount fees vary, so it is important to shop for the best deal and check out the organization and the contract closely.
About Author:
Andrew Cravenho is the CEO of CBAC LLC, an innovative invoice financing exchange. As a serial entrepreneur, Andrew focuses on helping both small and medium sized businesses take control of their cash flow. Prior to CBAC, Andrew founded an annuity financing company relieving tort victims of financial hardship.