No matter the size of the firm, many businesses regularly face cash shortages. When small or new businesses face such a squeeze the options are more limited. But if the business has accounts receivables, which is an asset that can be sold, "factoring" may be an option.
Factoring entails the business selling its accounts receivables at a discount to a third party known as a factoring company. The discount is the incentive for the factoring company to take a risk by advancing money on the receivables.
In a normal factoring deal, there are three participating parties: the business selling the accounts receivable, the one buying the accounts receivable (the factoring company), and one who owes the accounts receivable (customer of the seller or the debtor). The accounts receivable usually have to be owed by a dependable verifiable source that has a credit rating worthy of the factoring company its money
In the financial transaction of factoring there will be three components: (1) the advance, which is paid to the business seller as a percentage of the invoice face value, (2) the reserve, which is the balance held until the debtor has paid in full, and (3) the discount fee, which is the cost of the business transaction earmarked to the factoring company, including fees and interest detailed in the fine print).
Typically, factoring companies will advance up to 85 percent of the purchase price of the receivable. The factoring company then takes on the responsibility of collecting from the entity that owes on the accounts receivable.
Non-recourse or loan
Beware of the chargeback or set-off. If the company that owes the accounts receivable fails to pay and the debt becomes uncollectable, some factoring companies will often want their money back and treat the transaction as a loan rather than a straight purchase.
Non-recourse factoring is not considered a loan, because the factoring company will assume the risk of collection or non-collection. Non-recourse factoring is considered a straight sale of the asset. However, when the factoring company extends the money as a loan on receivables it is considered a secured loan. So if they cannot collect, they will circle back in the form of a chargeback or set-off to collect their money from the seller.
As it relates to Generally Accepted Accounting Principles (GAAP), there may be fine-line distinctions between a loan and a sale and the treatment of the money received.
Factoring companies are beginning to become more visible in the community. When doing business with one, do your research on the company and read the fine print. Ask for references and see if their customers are happy. If possible, have an attorney read over the contract as well. After all, you are selling or obtaining a loan against one of your most valuable assets.
AT A GLANCE
Memphis has a number of factoring companies, with Liquid Capital a new company on the block.
At Liquid Capital, the purchase price can vary between 80 percent to 90 percent of the total accounts receivable invoice. The variance is based on the client and the credit quality of the debtor.
Liquid Capital is a franchised business. In addition to the discount, the factory company will charge a 3 percent fee. This may seem steep, and the business seeking the help has to determine if there is enough mark-up in the receivables to afford this transaction without taking a loss.
So overall, the business needs to weigh the costs of this transaction very carefully and determine if this factoring is appropriate for its business model.
Factoring is not for every business. Although we advise those in need to proceed cautiously, sometimes this option can save the day.
(For more information about Liquid Capital, call 901-233-6624 or visit www.midsouth.liquidcapitalcorp.com.)