Taking The Fear Out of Factoring

With more and more reputable companies entering the factoring business, services have greatly improved. But factors' bottom line use remains the same: providing ready funds for companies in cash-flow-challenged industries.

When the United States invaded Afghanistan, the armed forces needed a great deal of infrastructure support, everything from electric generators to water purifiers to road-repair machinery. Among the companies the government contracted to supply such things, and get them to where they were needed, was a South Carolina outfit called IAP Worldwide Services, specialists in logistics. Before IAP delivered the goods, it had to buy them and meet payroll. IAP faced one of the classic business problems: Business was good but cash flow was bad. To get the required cash, the company turned to Rockland Credit Finance in Owings Mills, Md., one of a flourishing number of "factors." Factoring is among the oldest forms of banking (during the Renaissance it helped make the Medici family very rich), but it doesn't work the same way as an ordinary loan. Instead of advancing cash to a business on a pledge that it will repay the bank down the road, the factor actually buys the legal right to collect a company's outstanding invoices. The factor gets its money when the invoices are paid. The business gets its money now, minus a fee that can run as high as 3% of the amount due.

Factoring now accounts for more than $1 trillion a year in credit, triple what it was in the early 1990s. When the economy slowed down these past two years, so did factoring (after all, with fewer invoices to buy, less money could be advanced by factors). But insiders report that as of last summer, there has been the beginning of a turnaround. Factors are not only putting out more money but are willing to take greater risks than a year ago.

What's more, in what looks to be the wave of the future, tech-savvy factors have created online lending services that allow a steady flow of small invoices (sometimes just a few dollars each) to be paid to a business owner almost immediately. The factor takes care of all the paperwork, while the company follows the progress via the Web. Everything is covered, from generating the invoice (in what can look to the customer very much like a credit card transaction) to cashing the check to depositing the funds in the company bank account.

"We're online," says John Fox, of Rockland Credit Finance in suburban Baltimore. "The client can see all. Everyone is moving in that direction."

What has made factoring even more attractive of late to many smaller-size businesses has been the growing popularity of "cash management" by big companies. In real life that means small companies that sell to big companies can expect to be paid very slowly. "Can I put GE on credit hold because it takes so long to pay?" asks Helma Mazon, of Mazon Associates in Irving, Texas. "No. We know it's going to pay." The problem isn't getting any better. "They're teaching cash management at business schools," says Mazon. "Trust me. They are." In the last few years, ironically, credit bureaus that handle reports on people refinancing mortgages have become big customers of factors because the banks to which they sell the reports are experts at cash management. (And it's just too bad if they can't get a loan from the same banks that owe them money.)

Wal-Mart, the world's biggest retailer, has created a new class of companies that need factoring because it also stretches out its payments. The vendors can't complain because Wal-Mart is such a huge source of business. From the factor's point of view, this is an ideal situation, because there is almost no risk of Wal-Mart never paying up. Yet banks usually won't extend a loan to small companies in this situation because they typically expect a whole lot more collateral to back up a loan than just a contract with Wal-Mart.

Most companies are still better off borrowing from their bank rather than selling their accounts receivable to a factor. Bank interest rates are much lower than the "discount" the factor will demand when it buys the right to collect invoices. And it is literally a discount. A factor will typically pay 2% to 3% less than the face value of an invoice. A 2% discount for an invoice due in 30 days is the equivalent of a hefty 25% a year.

But banks are backward-looking: They want to lend against the balance sheet a company has already achieved. Businesses looking to expand may find that a factor will provide working capital for growth when the bank won't run the risk. Even with only a prospective order in hand from a client whose propensity to pay up is uncertain, a business can turn to a factor to see if it will assume or share the risk. And to the extent that a business has to take up time collecting, or worrying about uncollected bills, the factor offers a reduction in aggravation that may be worth the price of the premium.

"Cash flow is king, and it's the factors that give you the cash flow," says Larry Rosenblum, CFO of the magazine Nylon, which uses factoring to speed up the process of earning income off its advertisers. "The banks are concerned with the credit quality of their debtor, the small business. But the factor does credit checking on the people who owe you money--and then it takes the collection role as well. Factoring looks expensive, but all these other services are provided."

 1 | 2 | 3 | 4 | 5 | 6 | 7  NEXT