Factoring & Financing: Separating Fact from Fiction
A lot of small business owners think is too expensive to be a viable commercial financing option. Often that’s because they pay more attention to the factoring “interest rate” than the simple question: Does it work?
Usually, it does, which is why factoring is the most widely used form of financing in the world. Consider: The major credit card companies are essentially factoring companies. The merchant fees they charge -- usually 1 percent to 4 percent of the transaction -- are about the same as those charged by a commercial factor on a net-30 transaction. But would retailers stop accepting credit cards because they’re too expensive? If they did, most of them would soon go out of business.
More Expensive than What?
I’ve seen companies so wary of factoring that they go out of business rather than try it. I’ve seen companies pass up large orders, break promises to suppliers, and welcome strangers as partners. It’s my contention that these options are far more expensive than factoring.
Granted, factoring is more expensive than the interest rate charged by a bank on a traditional line of credit. But nowadays many small businesses can’t qualify for a line of credit large enough to meet their financing needs. A line of credit, after all, is not a right but a privilege. If you have one, be thankful and use it wisely. If you don’t, look seriously at the next best alternative: factoring.
After all, the least expensive option is not always the best one. In fact, the cheapest solution often costs more because it does not solve the problem. For example, what good is a line of credit if it’s not enough to meet the cash flow needs of a business? Factoring allows a business to grow quickly and build strong supplier relationships while freeing up the principals to focus on sales and profitability. It’s hard to place a dollar value on these benefits, but if you did, it would be significant.
A good factoring company also provides a host of back-office services, including credit checks, posting and ledgering of payments, and professional accounts receivable management. A full-service factor essentially becomes a business’s full-time credit manager, performing all the services of a full-fledged accounts receivable department. There is obviously a cost savings in that.
The True Cost of Factoring
So is factoring really so expensive? On the surface, yes, it is more expensive than a traditional bank line of credit. But it’s a lot less expensive than many other options.
The point is that if your company is in need of commercial financing, don’t be misled by common myths about the expense of factoring. Consider all of the components and all of the alternatives before you decide whether factoring is worth the cost.
Tom Klausen is president of First Vancouver Financial Services. He has extensive experience providing alternative financing solutions to small business owners across Canada. He also provides management consulting services to nontraditional lenders throughout North America.
