How a Company can Improve its Gross Margin with Factoring

"If I'm to pay a 3% factoring fee, and my profit margin is only 3%, how can my company benefit?
A company making only a 3% net profit margin can do more business volume as a result of invoice factoring, and the larger volume will result in a higher profit margin because fixed costs do not increase with volume. The added business at a higher marginal profit leads to an increased overall profit margin. As the volume increases, the cost of production decreases, so that profits increase. Fixed costs such as rent, trash expense, and administrative salaries generally don't increase with a volume rise. Utilities, telephone, and workmen's compensation insurance are expenses that will rise slightly, but not nearly as much as production costs do. Therefore, a company utilizing accounts receivable factoring can increase its volume and profit level.
kenth@ocflink.com
www.ocflink.com

Isn't Factoring Too Expensive?

I get this comment all the time: "Factoring is expensive compared to traditional bank lines". If you can get financing from the local bank that satisfies your needs, then do it. Unfortunately, not everyone can get a bank line of credit to fuel the growth of their company or bail them out of a financial hardship. If you're growing at an accelerated pace, the bank may not be able to keep up with your cash needs. If you're in trouble, the bank probably won't cooperate.

Invoice factoring is a way to get the cash you need when you need it. When deciding whether or not to factor your invoices, you should evaluate the incremental profits derived from taking advantage of this financing tool.

How are Factoring Fees Determined?

Invoice factoring fees can vary between 2 1/2% and upwards of 4 1/2% per month, depending on several variables. The difference can result in fee expenses of thousands of dollars to the average factoring client. The type of receivables you choose to factor and the companies you sell to are important in the overall rate that is charged.

Factoring companies place a great deal of importance on the credit standing of your customers. If Walmart is one of your customers, underwriting will look very favorably on funding those invoices (even though they are habitually slow payers). On the other hand, a company that is financially shady will cause the rate to go up.

Other factors that are involved in determining fees are total volume per month, average amount of invoice, and number of invoices to be factored each month. It might behoove you to not factor those invoices that are to poor credit risk companies or those that are comprised of several small invoices each month.

How Receivables Factoring Can Benefit Your Company

In many financial circles, the "f" word is not to be used. However, factoring is a well-established form of business financing that produces immediate cash payments to a company at the time of shipment, delivery and invoicing a customer. In its basic form, factoring has been used by American business since Colonial times, and its origins go back even further, literally thousands of years to the early days of commerce. Factoring has a bad name among some "experts" because of what is perceived as an excessively high cost of capital. But those who are able to put things in perspective know that when bank financing isn't available, other alternatives should be at least reviewed for viability. For example, lets say you have the opportunity to execute a new contract, but you need capital for production costs and overhead. Your friendly banker says he'd like to help, but your company is overextended. What do you do?

An analysis of how the costs of the contract could be funded by factoring should be performed. Will factoring provide enough working capital to pay the additional labor and overhead? If so, will the fees be covered to provide an adequate amount of profit?

Sadly, many business owners give up after a bank turn down rather than seek alternative forms of financing. The prudent thing to do is to take a few minutes and fill out an application for a factoring arrangement. The factor will know if your company is a good fit for this type of financing.

What is invoice factoring?

Put simply, invoice factoring is the sale and purchase of a company's accounts receivable at a discount. The transaction occurs between a company with existing accounts receivable on its books and a firm known as a "factor". The factor advances a percentage of the invoices submitted (usually between 75%-90%) in cash usually right after the invoice has been created. The difference between the face amount of the invoice and the amount advanced is called the reserve. Upon collection of the invoice, the reserve less the factoring fee is remitted to the client.

Factoring is designed for companies that have cash flow issues. Typically, firms with cash flow problems fall into two camps: those that have sustained significant losses and are having trouble paying current obligations like payroll and operating expenses, and those who are growing at a very rapid clip.

If a company wants to start factoring, they must fill out, sign and submit an application. In our next post, we will discuss the application process.