For companies of all sizes, cash is the life-blood for survival. This is particularly true for start-up and entrepreneurial ventures. There are many tools available to help manage cash flow. One of these tools that has recently gained wide acceptance is Factoring.

Factoring is simply the selling of accounts receivable to a finance company known as a “Factor”, at a discount. For example, “XYZ Corp.” may decide that it has a need for quick cash flow. At the same time “XYZ Corp.” may have a particular account with receivables of $1,000. “XYZ Corp.” would find a “Factor” and sell to that Factor the $1,000 receivable. At the time of sell “XYZ Corp.” would receive 70-90% of the $1,000, with the remaining 10-30% minus a fee payable at the time of collection.

Factoring has recently become very competitive, resulting in wider acceptance as well as a reduction in fees. Before deciding if factoring is right for a given company, one should understand the basic elements of factoring, weigh the pros and cons of factoring, and ensure that factoring fits the particular business’ operational characteristics.

Factoring – Elements

• A quick and easy way to generate cash flow. In most cases cash can be received within 24 hours
• Factors charge a transaction fee and take a discount of between 2-10% depending on factor period and size
• Factors generally pay 70-90% up front and the remaining 10-30% minus a discount upon full collection
• Factors’ decision to purchase the receivable is based on strength of the customers’ financial strength and not that of the seller of the receivable
• Factoring is flexible – companies can chose which receivables to sell, when to sell them and for how long they will sell them

Factoring – Pros and Cons
Pros

• Quick and easy method for obtaining cash
  
• Allows a growing company to take advantage of a big sales opportunity that poor cash flow would normally prevent
  
• Allows a company to take advantage of vendor discounts by paying invoices early
  
• Allows a company to extend vendor credit to a large and or important client
  
• Improves immediate cash flow situation
  
• Factors assume risk of non-collection associated with receivables
  

Cons

• If used as a permanent means of financing factoring can be much more expensive than conventional sources of cash
• Customers may not like paying and dealing with a third party – i.e. Factors

The beneficial application of factoring has a lot to do with the operational characteristics of a business. For example a company with very small margins would generally be ill-advised to use factoring, as fees would eat up profitability quickly. For companies with large amounts of cash on hand, factoring does not make sense either. If however, a company’s margins are large and cash in-flow is variable while expenses are steady, factoring might be beneficial for smoothing out the low cash flow periods.

Factoring, like vendor credit is simply another cash flow tool. It can best be used by shopping around for and setting up a relationship with a Factor before cash flow becomes an issue.

Factoring should be used sparingly to take advantage or large opportunities or smooth out short-term cash-flow lows. The internet is a great place to learn more about factoring and to search for a Factor that fits your business needs.

Richard Zollinger is a finance manager at American Express.

I recently read an article about eSys, a technology hardware manufacturing company. Founded in 2000, eSys saw revenues grow from $0 to $2 billion in 5 years. eSys had 112 offices in 33 countries, had acquired and turned around 12 money-losing businesses and had an astonishing $0 in long-term debt. So how do you grow a business, almost over night, from $0 to $2 billion in sales, without taking on any long-term debt? In eSys’ case one of the keys was vendor credit.

Vendor credit can be defined as buying something now and paying for it later or in installments. Unlike a bank line of credit or long-term debt, vendor credit is free or almost free. There generally is a cost associated with vendor credit, although it is implicit rather than explicit. By taking advantage of vendor credit you will likely forfeit any up-front discounts associated with paying a vendor early, usually 1 to 2 percent of the purchase price. However, if you want to lengthen your average payment cycle thus increasing your cash flow and growing your business, this implicit cost is well worth the price.

If you produce ice cream, you may ask the dairy that provides you with cream to extend your payment period. For example rather than paying for the cream within 30 days of invoice, you may ask the dairy to allow you to pay for the cream in 60 days. This is an example of taking advantage of vendor credit to lengthen your average payment cycle, to increase your cash flow and to grow your business.

So how do you go about convincing your vendors to extend you vendor credit? I have a few ideas:

-You have to ask! It is possible that if your vendors are not doing business in a competitive environment, that they will not come forward with the suggestion that you take advantage of credit they may be willing to extend. If this is the case, you will have to ask them to extend vendor credit to you.

-If you are a newly established business, you may need to convince your suppliers that you are credit worthy. That’s right, just like you have to sell your products or services to your customers, you may have to sell your business plan to suppliers. Take seriously the opportunity to sell your plan, be prepared to answer tough questions and show sincerity in your desire to be successful. If you are an established customer and have been loyal to your supplier, this sell should be much easier.

-Along with selling your business plan, help your suppliers to understand your potential success. Make a special effort to draw a connection between your success and theirs. You should also emphasis your interest in remaining a loyal customer for the long-haul. It is likely that a supplier will weigh the short-term risk, selling small amounts of product on credit now, versus the long-term benefit of huge sales in the future.

-Offer to personally guarantee some of the purchase price of your initial inventory purchase. Although this may be a bit scary, it may be necessary to initially convince suppliers that you are worth the risk.

-Buy insurance on whatever you owe your suppliers and name them as the beneficiaries. The cost of such insurance would be a fraction of the cost of conventional bank borrowing.

-Shop around! Visit with two or three suppliers about the potential of purchasing on credit. If your suppliers are in a competitive environment they will be more likely to sell on credit just to get or keep your business.

In summary, remember two things. First, in the business world “cash is king” - by using vendor credit you can conserve more of your own cash for growth. Second, using other people’s money, is always better than using your own.

Richard Zollinger is a finance manager at American Express.