Comparing Invoice Factoring to Bank Loans

One of the biggest objections I hear about accounts receivable factoring is that it is much more expensive than bank loans. When I hear this complaint, my initial response is to tell them that if a bank loan provides an adequate amount of working capital for their needs, they should go that route. But if the bank rejects their application for financing, they should keep an open mind about invoice factoring.

There are several reasons why comparing factoring to bank loans is like comparing apples to oranges:

First, factoring is not a loan. You are not borrowing money. Rather, you are selling a non-productive asset for a discount for immediate cash. Because of that, it is hard to compare a factoring discount of fee to bank interest rates.

Second, setting up an invoice factoring relationship is a simple and fast process. Funding can occur as fast as one week from the time the application is received. Compare that to the typically long and often difficult process of getting a bank loan. Even in the best of times, you must provide the bank with a lot of historical information, answer a lot of questions, and wait a long time to get approved by a loan committee. With the current chaos in the credit markets, the requirements are even more strict and difficult. Factoring offers immediate cash flow after the relationship has been established, with funds wired into your bank account within 24 hours of receiving your invoices.

Third, many factoring companies offer additional services that banks don't provide. For example, if you wish to add a new customer's invoices, the factoring company will provide credit screening free of charge. Collections can be done by staff members of the factoring company in a professional and courteous manner, which tends to lessen bad debt. Timely reports are provided on an ongoing basis, which helps the client keep an close watch on their outstanding receivables.

Fourth, Bank loans most always require personal guarantees from the business owners and they must often pledge other collateral. Factoring companies only require a first position on the business-to-business accounts receivable. No personal guarantees are required and no other assets need to be pledged. This arrangement not only gives the client the working capital it needs. The amount that can be factored is limited only by the pool of accounts receivable.

Fifth, start-up companies have a very difficult time getting financing in this era of tight credit. Not so with factoring. As long as you are selling to credit-worthy customers, a start up company should qualify for invoice factoring

In summary, the business that has been turned down for traditional financing should not get hung up on the cost of factoring. On the contrary, they should be more concerned with the cost of not using this alternative form of financing. In other words, they should look at the opportunity cost.

Let's say you've got a potential new customer that is ready to place orders with you, but you don't have the working capital on hand to produce the products they need. If you could use factoring to provide the cash flow necessary to pay the labor, buy the materials, and incur the overhead, would your business come out ahead? Using incremental profit analysis is something I strongly encourage business owners to do in order to determine if invoice factoring is good fit for their company.

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Tue, 9 Jun 2009 at 12:53 AM, by Sean Wesley
A well presented article. We would welcome such an inclusion in our own directory.


Sean Wesley
http://www.articlefountain.com

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