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Factoring: An Effective Way to Downsize and Outsource

by: Jerry Sandak
from: The Secured Lender

It’s 8:00 p.m. and Avery the entrepreneur is sitting at his desk trying to figure out how his business can grow without overhead or getting a partner. He begins to stroke the oil lamp on his desk and suddenly a genie appears. Being a wise businessman, Avery asks for the genie’s assistance in solving his business problems. The genie responds by asking Avery to recite all the things he wants to make his business more profitable.

“First, I would like the ability to screen orders quickly and to separate the good credit risks from the bad,” says Avery. “Next, I would like to ensure that I don’t incur any bad debts. I can’t afford a credit manager, a credit agency or credit insurance, therefore, I would like to have an accounts receivable department that would post all my invoices correctly. I would also like to have my statements sent in a timely manner, have my payments recorded quickly and correctly, and of course, a collections department to see that bills are paid promptly. That alone is a big expense,” he adds.

The genie is very attentive and lets Avery continue. “I would like to pay for all of these requests in relation to my sales. My business is seasonal. Sometimes we need a lot of help and sometimes only a few people. I really can’t afford to keep full-time employees. However, I’ve come to the realization that it’s not very effective to hire people only when I actually need them. If I could convert my uncollected accounts receivable to cash in order to pay my suppliers faster, then I could take advantage of discounts and make more purchases.

“Done,” the genie replies. “The first thing tomorrow morning, I’ll have a factor come over and see you.”

Avery reacts in amazement. “What? Me factor? No way!”

Why this story? The benefits of factoring have been well-kept secrets by the soft goods industry for more than 300 years, and the rest of the business world ought to learn about them. After evolving into its present-day form, factoring has benefited many clients. When America was still a group of British colonies, the English textile mills were actively seeking to sell to customers across the Atlantic. The English merchants did not know who would buy their products, nor did they know how they would get paid if they extended their credit. The American sales agents were anxious to do business and not only knew who wanted to buy textiles, but were also willing to guarantee payment to the mill and collect the money for them. This was the genesis of factoring in America.

From this beginning, factoring has evolved into the most efficient collateral management industry in the country. Approximately 15 major factors handle approximately $70 billion worth of sales for their clients, performing all the mundane functions a business requires by leaving the creative elements (sourcing, designing, marketing, selling) to the management of the clients’ companies, while providing the cash-flow assistance necessary to fuel rapid growth.

Two buzz words of modern business are “downsizing” and “outsourcing.” Factoring is the ideal way for a business to accomplish both. Efficiency of size comes into play because there is one credit department, one accounts receivable department and one collection department handling the needs of hundreds of clients. Each business pays only for what it uses, usually only a small percentage of sales and substantially smaller amount than if the company handled these activities on its own. The average factoring commission is less than one percent of the annual sales of a client. A company doing $5 million a year in sales could get credit guarantee, bookkeeping and collection services for less than $50,000 a year Ð less than the cost of one good employee.

Factoring can be applied to businesses beyond the soft goods industry. Today, virtually any company providing goods and services on an ongoing basis is a factoring candidate. An example: ABC Factors has two nontraditional clients that have benefited by using its factoring service. The first client started out as a distributor for Nintendo and Sega products approximately seven years ago. The company has only modest capital, but possessed excellent contacts in the industry, coupled with lots of ambition. With ABC’s advice, guidance and cash-flow assistance, it has grown large enough and financially strong enough to actually produce its own software. It now ships at an annual rate of $150 million and will soon distribute hardware. One of the principals of the company believes that factoring was the only way to fuel the company’s growth.

The second nontraditional client, a public corporation that distributes an herbal derivative in a number of forms, possesses even bigger potential. The company’s consumer base lends itself to factoring because drugstores, discount chains and other entities are already buying its products. The herb has been known for many years as having positive properties, and recent findings indicate it lowers cholesterol and reduces the calorie count of meat products. The problem: processing the seed to make it palatable. The company solved that problem and embarked on a substantial distribution program. Instead of setting up a large credit, accounting and collections department, it is factoring. The organization knows exactly what the cost will be and knows that nothing will be paid until receivables are created. Projections for the first full year of operations call for sales of $100 million.

Don’t get the wrong impression about these two accounts; you do not have to do $100 million worth of business to reap the benefits of factoring. Even clients with sales volume as low as $1 million need factoring services. At this modest sales level, the company obviously cannot afford to take a bad debt or hire internal credit, bookkeeping and collection expertise. Most importantly, the principal can direct energy to more productive areas that will help the company grow.

Factors are now considered the premier receivable management entities. With numerous years of experience, extensive databases and state-of-the-art computer equipment and programs, factors can offer their services to a greater variety of companies in various fields of different sizes. With increasing emphasis on growth and productivity, there are constant pressures to improve gross margins and computerization. Today, it is important for a company to have the benefit of a factor to help take it into the 21st century.

Being successful in the future will probably mean being global. If a company wishes to sell overseas, many factors can assist in two ways. One, they can help create and procure Letters of Credit to cover a sale and negotiate when the documents called for in the LCs are transferred to the factor. Second, factors can arrange for open credit to be extended through their relationship with Factors Chain International, an association of factors throughout the world. If a customer is in a country serviced by one of the member factors of the association, the company providing the product or service can receive the same credit guarantees and collection abilities that would be available if this account were based in the United States.

A factor with worldwide contacts in the banking and factoring community can check on the financial stability and reputation of the particular company the client plans to purchase from, helping to ensure that the company is capable of delivering whatever orders are placed.

Factoring offers an array of options from which the client can choose. The client is free to select options pertinent only to its current business requirements. And it can select other options as needs change. In any event, by using the services of a factor, the client gains a singular colleague who can provide administration, working capital enhancement, business experience and overall guidance.

With ownership remaining in the control of the client, the opportunity to grow and the direction of that growth can be chosen by management. With a factor at its side, a company’s free to focus on developing, producing and selling its product.