Among the oddities of the present state of the economy is that in the midst of plenty, commercial lenders are losing ground. Not only are their loans going sour, but so is the collateral behind them. This past summer, for instance, BankAmerica Corp. reported a record $640-million quarterly loss, and began monitoring its loan decisions more carefully. The customers of one of the country's mightiest financial institutions were forced to work harder for short-term working capital, or to look elsewhere. Some need only look to one of the country's humblest financial institutions, the hundred or so firms that constitute the ancient, and for the most part honorable, community of factors. Presuming, of course, the businesses understand that in many cases even a healthy operation can adapt factoring -- once considered the loan of last resort -- to its short-term advantage.

And there's the rub: factors remain underappreciated, even after three dozen centuries. A survey last year by Dun & Bradstreet Credit Services of 1,060 companies of various sizes disclosed that only 7% dealt with factoring firms -- or admitted to it. The aloofness of the other 93% was no doubt tinted by the popular view of factors as a pack of usurious Indian-givers who prey on desperate, capital-needy enterprises for quick profit. Some years ago, this appraisal was warranted to a degree, but as such reputable institutions as Manufacturers Hanover Corp. and The Fuji Bank opened above-board factoring divisions as a complement to conventional banking, factors have regained some respectability.

One reason for widespread ignorance of the financing technique of purchasing a company's receivables is that until recently most domestic factoring rode the coattails of the apparel trade, a sector whose growth was in large part spurred by factor underwriting. Another reason is that formulas for filtering capital through a factor are not standardized; the terms of a standard collateralized loan are often easier to pin down. Third, some so-called factors add to the confusion by selling themselves as factors even though they really do accounts-receivable financing -- a similar but separate service (see box, "Accounts Receivable Financing," page 136).

None of which ought to stop a business from at least considering a factor to solve short-term cash-flow bottlenecks, especially now that the core of the factoring industry is looking to expand beyond the patchwork clothing trade. Indeed, the financial force that kept garments from folding through the years applies to any enterprise that accumulates receivables. And though the terms may sometimes seem outrageous, they can foster growth better than traditional borrowing. "If you use a bank, you can do volume of 6 to 8 times your capital; factored, you can do 10 to 14 times capital," says Barry M. Pearl, vice-president and director of marketing of BT Factors, a $1.6-billion (in 1985 factoring volume) adjunct of Bankers Trust Co. in New York and among the 10 largest factors in the nation. How is this minor miracle wrought? "You're getting a much better cash flow," explains Pearl. "You can buy better, pay your bills faster, and get more credit." Furthermore, by committing only its receivables, the other assets of the firm remain as possible collateral for additional borrowing.

The factor issues credit at shipment, based on the amount of invoices cut by the borrower; on any given day, the greater the dollar amount of the receivables, the higher the credit line. At a bank, however, to enhance a similar credit line based on receivables pledged as assets, the line and the paper behind it would have to be reconsidered periodically -- if at all. "The more I talk to my banker friends, the more I am convinced that the banks really don't care about the smaller borrower anymore," observes Walter Kaye, founder of Merchant Factors Corp., a $40-million New York City firm begat of garments in 1985 and now moving into other small businesses. "They can't make any money. Their overheads are huge. It takes the same officer, the same time, the same policing, to put on a million-dollar loan as it does a quarter-million-dollar loan. They want it collateralized by outside assets they can touch and feel. They love real estate."

His conclusion is not entirely self-serving. Banks are not in the collection business, and would be unlikely to take on asset-based financing as their sole function to a customer. They would expect the rest of that customer's banking business as well. But not factors, who exist comfortably enough outside banking regulations and are thus free of the strictures of the system; factors want only that function, and the borrower need not mortgage its soul. "If an account is marginal, in tough times he won't get a bank to loan him anything," observes BT Factors's Pearl. "We are more liberal." Which makes a factor sound a bit like Santa Claus. Fat chance: a factor takes risks, and with risk there must be compensating reward.

Factors make their profits by acquiring a company's invoices and collecting on them, charging the company a fee. Simply put, there are two variations. One derives the fee by discounting up front the face value of the invoices; the other by lending against the receivables until they are collected, charging daily interest on the open amount plus a onetime commission. Either way, the essential point is that, unlike a bank, the factor buys, pays for, and owns the receivables outright. The risk is that if they go bad, the factor suffers the loss.

If they don't go bad, the reward is that a factor's return on investment can exceed conventional lenders' returns. To cement that happy ending, factors execute thorough credit checks on each debtor before buying the invoice from the issuer. Indeed, unlike banks, to some factors the financial condition of the latter hardly matters. "We do not look toward the business that comes to us selling its receivables, but to the strength of the receivables it is selling. The capitalization of the business is not crucial," says David B. Clark, founder and partner of a West Coast group of independent financial firms doing $200 million a year.

A wide-ranging financier with specialties in oil, aerospace, importing, and transportation, Clark currently discounts his purchases by about 6%. That is to say, for every $1,000 in receivables, the seller receives $940, and the deal is done. While a few scatered factors discount according to a schedule, paying a smaller percentage up front and throwing in more depending on whether the receivable is collected within 30, 60, or 90 days, Clark's is a onetime charge. The factor then takes over the entire collection process, including mailing out the invoices. Each customer is notified that the account is owned by and payable to the factor. If the factor gets the check in 45 days, essentially the client has been charged 4% a month. If the businessperson continued to sell his receivables on the same basis, over the course of a year, he would be paying 48% for the early use of money.

An unconscionable rate, perhaps, but factors aren't bankers, nor is that transaction a loan. It's an outright purchase, and a factor's client gets the cash immediately. "Maybe it sounds high in comparison to bank rates," admits Clark, "but remember, we bear the risk. No banks are going to bear risk. They don't like to get involved with anything administratively burdensome. Yet that's where we shine. Paperwork is our forte." Of course if the factor doesn't collect promptly, the return is not so attractive.

From the client's point of view, the arrangement is akin to a guarantee that his customers will pay all his invoices at once, and he doesn't have to rely on a bookkeeping clerk to perform credit checks and pursue laggard payers. And a debtor is apt to pay a factor faster than he would pay an individual vendor, if only to keep his reputation in good standing among credit watchers. On the other side, if some abstract entity is doing the collecting, the client business feels more comfortable selling goods to a customer while not at the same time trying to collect on the last sale. Let the factor be the bad guy.

An alternate school, taken from the garment industry, varies the basic setup, but the end advantage turns out much the same. As the process is executed by Merchant Factors, the factor likewise buys the receivables, but rather than discounting them up front, this method treats the advance as a loan. A Merchant client must agree to sell the factor all of its invoices on a continuing basis and pay a onetime commission of up to 2% of the value of the invoices. He is entitled to an advance of 70% to 80% of all the invoices he can create, and daily interest at 3.5 points over prime is charged by the factor until the bill is paid. Merchant's rates tend to be slightly above prevailing factoring levels because, like originating banks that resell the mortgages they buy, the 10-man Merchant operation refactors its receivables, turning around and selling them to a prime factor, and then arbitraging the difference in costs. "We're entitled to, since we're taking small accounts and bundling them to [the clients'] advantage," explains founder Walter Kaye. "Their accounts are treated as if they're doing $40 million." Without its united-we-stand posture, argues Kaye, Merchant's 60 small-business clients, typically manufacturers capitalized at $60,000 to $150,000, selling $500,000 to $2 million worth of goods to retail stores, undoubtedly would fall outside the purview of the factoring industry's mainline firms.

The factor does all the administration and collecting under this structure as well, but the client has some exposure to the quirks of collection, inasmuch as if he takes the advance, he is obligated to pay interest until the invoice is closed out. This way, the factor is protected against collection bouts that may drag on unpredictably. However, a borrower ought not to be overly concerned with the extra interest expense if receivables exceed predicted aging, since the money -- which otherwise he wouldn't have at all -- can instantly be put back to work. Let's say, with the prime at 8%, a manufacturer taps his 70% allowance by borrowing $1,000 at 11.5%, and the receivables remain open for 45 days. Interest plus 2% commission on $1,428.57 (the amount of which $1,000 is 70%) comes to about $43. That's the equivalent of straight interest at about 34% per annum, but factors would be quick to point out that the expense is negligible in relation to the cash-flow benefit of being able to count on the money coming in. "That's the attractiveness of factoring," says Kaye. "It takes a small-business man with limited capital and enables him to compete in the marketplace."

A somewhat larger business can get better terms from such large firms as BT Factors, which, after decades of apparel and related industries, has added toys and shoes, and is looking toward housewares, electronics, paper, and, Pearl pledges, "anything we can get credit information on and that creates an invoice." As of this summer, an average client was paying 1% to 1.25% commission, plus 2 points over prime on advances. BT likes to see a client doing sales of "$5 million to $15 million, but we can go from there upward to $100 million, no problem." But, says Pearl, BT would consider as little as $1.5 million in sales if there were growth potential. "When we find someone is going nowhere, we don't have much interest. Generally if there's no growth, the firm dries up. You go one way or the other; in business, it's hard to stand still."

Beyond quick access to revenues, a factoring client is also buying insurance against bad debt. Factors' credit checks are so painstaking that few receivables are uncollected (and most of those not due to credit unworthiness but to other complications). For that reason, some companies elect to sell their receivables, but not to be paid until the factor receives his payment -- an interest-free process called maturity factoring. For a commission of 1% to 2% (depending on the average amount of the invoices), the client is acquiring both a bookkeeper and a crackerjack credit department. And its principals can sleep as soundly as General Motors's: if a financial catastrophe such as a Chapter 11 sullies the receivables, the factor pays the client immediately. Short of that, the client gets paid after an interval that both parties agree constitutes a bad-debt situation. Considering savings in overhead, payroll, and collection inefficiencies, a business doing, say, $10 million may actually come out ahead for its $100,000 fee. Besides, the fee is an expense and comes off taxable income, so Uncle Sam kicks in as well.

In addition, a client gets free business advice whether he wants it or not, since it's to a wiser factor's advantage to help the business run smoothly. "A distribution problem? How to write the other partner out? How to set up a buyout? We charge nothing extra for consulting," says Kaye.

When the chips are down but the cash isn't, an independent factor can customize financial services to fit the peculiarities of a business beyond the pledge of its receivables. This flexibility stems from the old days in the apparel industry where, based on the mere promise of a big order, factors might back a production run while the invoice was but a gleam in the hard-pressed garment-maker's eye. Merchant's Kaye claims he makes advances against some invoices that normally would be rejected because credit could't be verified "on the theory that if the businessman is willing to take the risk, he knows the customer. I have to go along with it and make money available." And Clark has set up a cash service devoted to assisting transportation brokers in contracts with carriers. Clark covers gas and breakdown costs stop by stop as a hired truck crosses the country, and pays off the driver as soon as a receipt is signed at the destination. Doling out funds en route enables him to track the truck and prevent chicanery; as to rushing the driver's pay before the invoice is issued, "it promotes stable truckers," is Clark's rationale. "Once you go into an industry, you better know about it. Asset-based lenders will take other forms of collateral, but then you get into the business of collateral liquidation. The last thing I want to do," says Clark, "is liquidate some man's home."

Find a bank so kindhearted.