Turn your receivables into quick cash

November 21, 2008: 10:50 AM ET

"Factoring" can be a godsend for growing businesses that need to smooth out their cash flow. Here's what you need to know about it.

Gary, San Jose
Can you recommend a reliable factoring company? Is there any factor company that can work with us to invoice our clients using our name, so that our client doesn't know we've factored our receivables?

By Kathleen Ryan O'Connor, Fortune Small Business contributor
First, a bit of background on the practice. Factoring is essentially selling your accounts receivable in exchange for cash up front. You get a percentage of the value of your invoices, say 70% to 90%, now instead of 30 or 60 days out.

In exchange for the quick liquidity - some factors can get you cash in just 24 to 48 hours - you pay a fee that can range anywhere from 1% to as high as 15%. When your client pays the factor, they keep the amount they've advanced you and send you the balance.

The practice has come a long way from its past image as something reserved for businesses with bad credit. Rapidly expanding but cash-starved startups and companies forced to wait a long time for payments from solid clients are particularly well-suited to take advantage of the practice.

The downside is that factoring can be more expensive than a traditional lender - think of it as more akin to a credit card than a bank loan - and in small-margin businesses, the cost of factoring can cut too deeply into profits to make it sensible.

"Factoring is very good when your business is growing, but it's not a savior for a dying business," says Scott Applegate, COO of CapitalPlus Equity, a factoring company out of Knoxville. "All it would do for a dying business is prolong the death."

Dave Theobald, a critical-care nurse who founded his own medical staffing firm for nurses in 2004 in Clifton Park, N.Y., Stat Staff Professional, says the factoring relationship he established with Anchor Funding Services was crucial to the his business's growth.

As a staffing firm, his company's single biggest expense is payroll - and its payments largely come from hospitals, which are notoriously slow to cut a check. In two years, his monthly payroll grew from about $10,000 to $2.3 million. Factoring allowed him to meet his cash-flow obligations and to keep expanding, he says.

It's a great time to be in the factoring business. As the financial crisis continues to squeeze credit markets, small business owners are left looking for new avenues to raise cash.

"Business is up," Applegate says. "Typically when banks tighten up, our business - or at least the business opportunity - gets better. But when that happens, there are a lot of people who are fraudulent looking to get into the business." Factors also report seeing a jump in bogus invoices in tough times.

The Commercial Finance Association, a trade group, says U.S. factoring is enjoying strong growth. Their most recent survey shows U.S. factors had a transaction volume of $135.3 billion in 2007, up 6.5 % from the $127.6 billion they did in 2006. That figure represented a nearly 13% increase from the year before.

Another reason small business owners may like factoring is that the factor can essentially function as an outsourced accounts receivable and collections department, freeing the owner to concentrate on other aspects of the business.

The credit of your clients will play a major role if you contract with a "non-recourse factor," one of two types of factoring companies and the most prevalent. Non-recourse factors take on all the risk if an invoice is not paid, which gives the business owner some shelter from the risk - but they change more for the service. "Recourse" factors, which have lower fees, do not assume that risk. If your client doesn't pay up, you'll have to repay what you've been advanced.

Dealing with credit and payment issues can be a huge burden for a small business owner. When you consider that a factor takes over that work, factoring can be cheaper than a bank, says Kevin Gowen, CEO of AmeriFactors Financial Group in Celebration, Fla.

As for recommendations, we can't single out a company, but Bert Goldberg, executive director of the International Factoring Association, says his group offers its membership database to the public and that those who join sign an ethics pledge. You might also want to check with the Better Business Bureau for any complaints against a factor you're considering.

As for whether or not you can make it seem like payments on factored invoices are still coming back to you, the short answer is, it depends. The companies we talked to are happy to work with clients on such issues, but in general payments will go to a P.O. Box accessed by the factor. Some companies tout their ability to make their role invisible, billing customers under their client's name.

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