What to Look for in a Factoring Company?
One of the biggest challenges small business owners face is maintaining a consistent cash flow that allows their businesses to operate and grow at optimum levels. With that said, it is more often than not their inability to control the collection of accounts receivables that creates many cash flow issues. If customers won’t or can’t pay, there is little a business owner can do other than wait it out and hope the money starts flowing in soon.
One thing business owners can do is factor their accounts receivable and turn them into immediate cash that can be used to keep their businesses moving forward.
If you find yourself as a small business owner watching your receivables grow while your available cash shrinks, enlisting the services of a factoring company might be your best option. In the sections below, the information will focus on the definition of factoring and how you can find the right factoring company.
What is Factoring?
Factoring is the process of turning outstanding receivables into cash for immediate use. This process allows business owners to circumvent the 30 to 60 days it normally takes to convert receivables into cash.
Factoring companies (henceforth referred to as “Factors”) will purchase a company’s receivables for some percentage of the true value of the receivables as a whole. The percentage a factor will pay will depend on the total value of the receivables and the perceived creditworthiness of the company’s customer base. If a business owner can end up getting a total of 97% to 98% of the true value of their receivables in the end, that’s often a reasonably good deal.
What to Look for in A Factor
It’s fair to say there are plenty of reliable factors operating throughout the US. That doesn’t necessarily mean they will all be able to help you meet your goals as a business owner. To help you weed through and select your best factor option, here’s some things you should consider.
Type of Factoring Available
There are two primary types of factoring: recourse and non-recourse. With recourse factoring, you would be required to repay your factor for any amount they are unable to collect from your customers after all reasonable efforts have been put forward. Non-recourse factoring would be the opposite, you would have no obligation to make your factor whole.
If you want the non recourse option, you’ll have to offer a bigger percentage of your receivables to compensate for the factor’s higher level of risk. You have to decide which of these options makes more sense for your business. If you trust your customers, recourse factoring might make the most sense.
Advance Rates Available
The money you would receive from your factor would come in two installments. The first installment is the cash advance rate or deposit. You’ll get the remaining portion of the factor contract after your factor has successfully collected all applicable receivables. You should be looking for factors that offer the most competitive advance rates, say around 75% to 85%.
Competitiveness of Pricing
Keeping in mind factoring does offer some risks for your factor, you want to find a factor that is offering competitive pricing. In today’s market the factor fee rate should be between 1.20% to 3.5% for 30 days. Since each factor is likely to view a receivables portfolio differently, you should get quotes from at least two reputable factors.
Minimum or No Minimums
If your receivables are relatively small for your industry, you might have difficulty finding a factor that is willing to deal in low volume factoring. Since factoring with higher minimums often offer better rates, you would need to find a factor that is willing to take on your current receivables portfolio with some degree of flexibility.
Reputation and Business Longevity
As an industry, the factoring business is always evolving with companies rapidly coming in and leaving the industry. First, you want to find a factor that has a reputation for good and quick customer service. Second, you would be well served to find a factor that has been doing business in your industry for a least a few years. You don’t want to put yourself in a position where you are always on the search for a new factor because the current one is closing shop.
Factor’s Cash Resources
You are well within your rights to ask each factor where they get their funding. What you want to look for are factors that have the in house financial resources to fund your receivables. If a factor has to depend on a line of credit to handle your business, there’s a risk to you that they might have limitations on how much of your receivables they can handle at any given time.
Using the above criteria and good judgement on your part, you should be able to find a factoring company with which you can do business with a minimum of concern.