Factoring

SELECTING A FACTOR

Selecting a factor is much like selecting any other service provider. The objective is to find the best price for the services provided. Several considerations that should be weighed by the small business owner in making fee arrangements with a factor include:

• Recourse—Small business enterprises that elect to go with a recourse factor (in which they bear final responsibility for collecting monies owed) over nonrecourse factors (where the factor company bears that responsibility) will find that they may gain lower fees and more money from the factor in return for increasing their risk.
• Customer Base—The larger the number of customers a business has, the more cost advantages the factor can offer the business. Automation provides factors with significant economies of scale when a large number of customers are involved.
• Creditworthiness of Customers—Factor companies will assess the credit worthiness of a business's clients and use this as an important element in pricing the factoring services for that business. Factors will not purchase substandard customer balances.
• Size and Age of the Average Invoice—Smaller receivables that have been on the books for a while will result in less advantageous factoring arrangements for small business owners than will large, current receivables.
• Factor Preferences—Some factors tend to work with larger businesses, while others concentrate their efforts on smaller enterprises. Large factor companies tend to focus their attentions on companies that have at least $10 million in annual sales, while smaller factor companies—sometimes known as "re-factors"—may provide services to companies with annual sales as low as $300,000.
• Industry Knowledge—Most factors that reach agreements with small businesses will have a fairly solid understanding of the industry and competitive environment in which those businesses operate. Such factor companies can provide help to small businesses in determining who they should (and should not) extend credit to. In addition, factor companies can be helpful in settling upon credit limits for both new and existing customers.
• System Compatibility—Most businesses in today's environment have implemented automated processes to calculate and monitor accounts receivable and cash applications of cash received. Small business owners should make sure that their systems are compatible with those of the factor before agreeing to a factoring arrangement.
• Collections—As indicated above, this can be a tricky area for the small business owner. Handing over collection duties to a factor company is expensive, and over-aggressive collection efforts on their part can damage a small business's relations with legitimate clients. However, factor companies often have better luck in collecting money owed than do small business enterprises, which have more limited resources to dedicate to the collections process. Business owners should recognize, however, that the factor is only interested in business transactions in which their client is owed money. Factors will not be responsible for non-payment that is attributed to other issues, such as vendor disputes or defective merchandise.

A variety of institutions, including bank subsidiaries and finance companies, provide factoring services. These companies can be found via several different methodologies. The Commercial Finance Association offers a list of its members and their service offerings online at www.cfa.com. Many factoring businesses also advertise in local yellow pages under such headings as "factors," "financing commercial," "accounts receivable financing," or "billing service."

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