It’s a familiar problem for most temporary employment agencies. Your biggest customers are loyal and financially sound, but slow to pay due to corporate red tape or a longer billing cycle. That’s no problem — for them. Meanwhile, you’ve got your own people to pay — employees, suppliers. You need cash and you need it now.
There are many ways to generate cash flow. However, not all may be right for you. If your business is small or new, you may not qualify for a traditional working capital loan. Or you may need cash flow assistance above and beyond such a loan.
One alternative is to hire a factor. A factor is a company that purchases receivables, giving your business an advance payment up front. It is a mode of financing that can help free businesses from the cash-flow squeeze caused by slow-paying customers. As an end result, a business can generate instant capital and more easily predict and manage its cash flow.
Companies in the services industry are particularly well-suited to factoring as a financing tool. Temporary employment agencies illustrate the process well. Temporary employees placed must get paid on a weekly basis but many of the clients are larger companies that may take longer to pay. Factoring can help such a firm cover its cash flow.
Despite the benefits of factoring, many businesses do not take advantage of this financing tool, either because they are unaware of its availability or due to misperceptions on how it works.
Factoring has been used by businesses around the world for more than four centuries as a respected way to manage cash flow. For example, nearly all of the financing done in the garment industry is done through factoring. Additionally, every time a restaurant processes a payment by credit card, it is engaging in a process similar to factoring, since the credit card processing company advances the restaurant the payment immediately and then collects the money. Today, it is estimated that factoring is a $100-billion-a-year industry in the United States.
Factoring works like this: A factor purchases its clients’ invoices and immediately advances most of the invoice amount in cash. The remainder of the invoice amount is remitted to the client upon collection, minus a small service fee. Ideally, the fee should be all-inclusive and not exceed from two and a half to four percent, based on the credit and collection characteristics of the client and its customer base. In selecting a factoring company, it is important to have the factoring firm specify up front if there will be any additional processing, administrative or other hidden fees in addition to the percentage charge.
Invoices can be purchased individually but usually are processed in batches as part of an ongoing account. Depending on the factor’s scope of service and the needs of the client business, a factor can handle other administrative tasks as well, such as helping keep a company’s accounting up to date, assisting with collections and advising on tax requirements and other issues. For a small business with a lean staff, these services are worth consideration.
Is factoring right for you? Traditionally, this mode of financing works best for small to mid-sized companies that don’t have much collateral yet or start-ups that haven’t developed an established relationship with a bank. In the latter case, it can be the temporary financing measure that fills in until a working capital loan is possible. Factoring also fills a need for rapidly-expanding companies who are outgrowing their operating capital.
Editor’s Note: Greg Curtiss is President of The Invoice Bankers. Mr.Curtiss is a lawyer and has passed the CPA exam. He has been in business for over 15 years. You can reach him by calling 303-740-7600 or 1-888-740-1750.