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Factoring: Funding Secret of the Giants

“Factoring: Funding Secret of the Giants”

Factoring is the sale of accounts receivables to financing sources. This means that your longer-term receivables can be made available to you in a much shorter time period. This article explains all of the uses that the cash could have in your hands, considerations to keep in mind when seeking a purchaser of receivables, the financial mechanics behind factoring, as well as a question-and-answer session on the topic.

Factoring is a cash management technique which has existed for decades. It is perhaps one of business’s best-kept secrets. It has been generally available in the U.S. only in the textile industry and to manufacturing giants. Now that is all about to change. Factoring is becoming available to all of us.

Factoring allows a business to receive immediate cash for goods or services sold, instead of waiting 30, 60, 90 or more days for payment. Thus, working capital is immediately available to meet payroll and other obligations, buy more materials and take advantage of volume discounts and remove debt from the balance sheet.


Traditional factors won’t touch invoices less than $500,000, but a growing number of smaller factors are opening this service to smaller businesses. A Certified Factoring Specialist (CFS), a person trained and certified in the field of providing factoring services, can locate a factor able to provide cash for invoices to virtually any business which creates commercial invoices.


As a manufacturer, you may find yourself needing to purchase or upgrade automation equipment in order to compete in terms of quality, productivity, specifications, and cost of production. You may not wish to or be able to finance this upgrade. Through sale of your accounts receivable, you have the cash to make the necessary improvements.


As business owners, we have all had sleepless nights and knots in our stomachs waiting to see if our customers would pay before payroll checks are due. We may have friends who were surprised by a late payer and were unable to make a tax payment when due. This worry is eliminated through factoring. You know when you will get paid — as regularly as your employees expect to get paid.


Even if you are not in need of new equipment and your cash flow always is sufficient to meet payroll and other obligations when due, factoring may still be for you. Extra up-front cash may allow you to pay off loans and liens and improve the bankability (sellability) of your firm. You may decide it’s time to pay yourself back for all the money, blood, sweat and tears that you have invested in growing your business.

Factoring does not provide venture capital. Factors have no interest in being your partner and taking ownership or control in your firm the way a venture capitalist does. Your business is your business. The factor’s business is cash flow management. Factoring relieves you from worrying about cash flow so your undivided attention may be focused on marketing, product development and other business expansion activities. Factors do not show up in your financial statement!

Depending on your needs and desires, your relationship with your factor can evolve to provide you with other services. Some factors are able to take over your entire accounts receivable department, manage collections, insulate you from bad debts and provide advice for business expansion activities.


  • Do you need cash to meet payroll, tax deposit or other financial obligations?
  • Is your credit line tapped out or nonexistent?
  • Would you like to clean up your balance sheet by reducing or eliminating debt?
  • Do you need cash for office/plant improvements and modernization?
  • Would additional cash allow you to increase sales, take advantage of volume discounts and expand your business?

If the answer to one or more of these is "Yes," then factoring may be for you. Your CFS will be able to thoroughly analyze your business position and assist you in making the best decision. Factoring should be seen as a strategic business resource whether you find yourself strapped for cash or poised for expansion.


The roster of smaller factors is changing on a daily basis. A CFS is trained to locate the factors interested in your particular line of business, to compare terms and to present you with the most competitive offer. A CFS can track how well each factor services its clients and other particulars on how the factor does business. In particular, a CFS will have answers to questions such as these when evaluating factors:

  • Does the factor purchase invoices in your particular business or line of work?
  • Does the factor purchase invoices in the size range you generate?
  • How promptly does the factor advance funds upon receipt of an invoice?


The bane of small business owners is cash flow management and analysis. Proper development and use of a cash flow projection is necessary in managing the finances and growth of a company as for positioning that company for traditional financing. This tutorial demonstrates the use and analysis of a cost flow projection.

In the following scenario, we are successful business owners with $10,000 in hand. Our monthly sales are at $50,000 and are growing by $5,000 per month. For our projection, we assume invoices are paid on an average of 45 days after the product/service is delivered.

Scenario 1

As you can see, profits are good ($5,000 to $9,000/month). The problem is one of cash — without an infusion (probably a personal loan) of some $6,000 or more (depending on when our customers pay), we would not have been able to pay the rent and payroll through March!

We perform a careful analysis of this projection. We learn:

  1. if we continue to be this successful, we will soon be bankrupt;
  2. we have no cash cushion to tide us over should sales suddenly decline;
  3. we don’t have the resources to expand if the opportunity comes along.

We had over $10,000 in profits the previous two months. Where did the money go? The answer lies in the last line of the table. Our receivables are growing at almost the same 10% rate our sales are. But percentages are not what matters — it’s gross amounts. Dollar amounts of expenditures are growing faster than dollar amounts of collections. We are profitable but have no available cash. Using our receivables to fund our business may result in a Scenario 2.

Note: We don’t have to lend ourselves money to pay rent and other expenses each month. We also have cash profits to take home.

Scenario 2

You will note that "profits" are lower, but they are still there. The best thing is we actually have the cash to take the profits home — to eat and pay the bills. Nothing is more frustrating than having a profitable business and paying the mortgage off you Visa card. We are also establishing a significant balance sheet, one which does not show your cash balance each month at $0 (or below). This is an important step in developing the commercial references necessary to make our business "bankable."

Through factoring, we have the cash on hand to expand operations further. If in the first scenario, we had the opportunity to double our sales one month, instead of "Cost of Goods" in February being $38,500, they would be $77,000! Where are we going to get the extra $38,500 needed to pull off this deal? In scenario 2, we have an ending balance in February of $76,527 — this is almost enou
gh to pay for March’s projected goods’ cost as well as pay for the extra $38,500 in costs in February. Assuming you have made it this far in this tutorial, please consider one more table comparing February from Scenario 1 with February with doubled sales from Scenario 2.

Scenario 3

This presents our options for a strategic plan toward business development. To recap, we have the option to:

  1. Be conservative, make an 11% profit, have no money to take home and risk stifling operations through lack of capital.
  2. Through factoring, make a profit of 6%, have cash in the bank and money to eat on.
  3. Take advantage of having that cash, make a 16% profit, actually GROW our business (and have money to take home).

Reality will put us somewhere between two of these three options. The point is without a plan for financing your business, it is very difficult to overcome the cash-success paradox: The more successful your business is, the less cash you have on hand.

Of course, this is a purely fictional scenario. Please use it as guide to help you model and plan your cash flow and business growth. You have to use your own numbers. You have to be certain that your business is profitable — if it isn’t, you have what the bankers call a "basic business problem." If it is profitable, plan your growth and manage your cash.

Glossary of Cash Flow Terms

Sales — Commitments by customers to purchase which you have satisfied in the current month. Establishes a "vested right to payment" from your customer to you.

Receipts — Actual receipt of moneys owed you by customers for current or previous sales.

Accounts Receivable — Money due you from previous sales.

Variable Expenses — Expenses which may vary from month to month depending on sales volume. Items may include cost of goods or raw materials, handling, delivery or processing costs for those materials; and journeyman contract labor required for setup or installation (such as a part-time carpet installer).

Fixed Expenses — Expenses which are basically the same from month to month (for example rent and full-time office staff). They may vary and can be controlled but do not depend directly on sales volume.

Profit — Amount of sales less amount of costs incurred during the month.

Cash on Hand/Ending Cash — The actual amount of cash on hand (in the bank) at the beginning or end of the month.


  1. What is factoring? Factoring is you selling your receivables, for immediate cash, at a small discount.
  2. Who should consider factoring? Companies use factoring for any or all of the following situations:
    • The company went to the bank, but could not get funding.
    • The company needs cash immediately.
    • The company is growing fast and needs to improve cash flow.
    • The company can use the cash to get cash discounts from suppliers.
    • The company has lower personnel expenses because the factoring company can handle collecting the receivables.
  3. If the bank wouldn’t take me, why would a factoring company work with me? For two reasons:
    • Banks are heavily regulated.
    • A factoring company bases funding on the credit-worthiness of your receivables, not you.
  4. How much is that small discount? It depends on the nature of the businesses involved, but 4% to 7% is to be expected for most businesses.
  5. Isn’t 4% to 7% rather high? Compared to what? A factoring company is not a bank and provides valuable services that a bank will not provide. These are:
    • Immediate funding up-front, without debt, and optionally, with the effect of credit-risk insurance.
    • Credit information services. As your business grows and you acquire new customers, the factoring company investigates the credit-worthiness of those customers whose invoices you will want to sell. You stay informed concerning the credit-worthiness of your customers.
    • Collection services. A bank will not collect on your receivables for you, whereas a factoring company collects the receivables that it has bought. This saves you the time and expense of collecting on your receivables.

    In general, receivable financing is tax deductible financing. You can write the small loss off on taxes. (Check with your accountant for applicability to your business.) Remember companies use the money they receive from the factoring company to take advantage of supplier discounts. This allows them to save almost as much as the amount of money they gave up discounting the A/R. This results in the company losing little or nothing in cash because they discounted the A/R. You may be able to do the same.

  6. What is credit-risk insurance? If the receivables from a customer should become a bad debt, the factoring company takes the loss. You received your money up front. This is known as non-recourse factoring because the factoring company has no recourse against you. Please note that this is optional.
  7. Do my customers have to know that I’m factoring? It’s your choice. If you are using the recourse factoring, your customers do not need to know.
  8. How much money do we get up front? Up to 90.1%. The exact value is negotiated with the factoring company, but is generally 80 to 90 per cent. When your client pays the total amount on the invoice, you receive the rest of your cash on the receivables, less the appropriate discount.

About the Writer: Tom Graham is founder and President of Access Funding, a business which specializes in locating alternative sources of cash for small and growing businesses. In addition to receivables funding, Access Funding assists firms in locating and placing leasing, vendor credit and venture capital transactions. For more information contact Tom Graham, Access Funding, at (301) 587-0067 or Fax: (301) 587-0069.

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