Factoring a Factoring Company into Your Business
A common practice for many apparel and printing concerns, factoring is the process of selling-on receivable invoices to a third party — usually a factoring company. The factoring company then collects the monies owed from the apparel company’s customers.
Why Would you use a Factoring Company?
There are two advantages to this kind of financing. Firstly, customers can be slow to pay invoices, possibly putting the company under a bit of financial pressure. Secondly, the apparel company may need to have cash on hand in order to support more production and make additional sales. If all the apparel company’s financial resources have been used up they will have to wait for their invoices to be paid before they can start producing more goods again. In this way factoring companies can assist production by “buying up” these owed invoices to free up cash and allow the apparel company to keep producing without having to go into debt, or halting production until their accounts get paid.
How does a Factoring Company Work?
Factoring is a fairly simple process with most factor companies using the same model with a few variations. There are usually four steps in the process of factoring:
Step 1: The Invoices
Apparel Company “A” submits its invoices to Factor Company “F.”
Depending on the arrangement with the factoring company this transaction is sometimes called “selling” the invoices, or “insuring” the invoices. Either way, Apparel Company A hands over the invoices it is owed, to the Factoring Company.
Step 2: The Advance
Factor Company F advances Apparel Company A up to 90% of the money owed on the invoices.
This percentage can vary from factor to factor. Some will offer a high initial advance (70-90%) and others may offer lower amounts. This advance frees up cash for the apparel company to continue production without having to wait for money to come in from those outstanding invoices.
Step 3: Your Customers Pay The Factor
The Factor Company contacts the Apparel Company’s customers and, in turn, they pay the Factor Company in 30 or 60 days as their invoice specifies.
Once the Apparel Company has received payment from the factor company, the factor company “owns” the outstanding invoices and is free to collect on them.
Step 4: The Rebate
Once the customers have paid Factor Company F, Company F will give the Apparel Company A a rebate. The rebate is the balance of the outstanding amount on the invoices. For example, if the advance the Factor Company provided was 80% of the value of the purchased invoices, then the rebate will be the remaining 20%.
However, factoring companies always take a fee for the financial service which they provide. This fee is based on the risk which they take if one of your customers does not pay them, or pays late. So, the final rebate is usually 20% minus the fee.
Disadvantages of using a Factoring Company.
Factoring is a financial arrangement which has been around for centuries. In spite of this, factoring is still not federally regulated in the United States, which means its practices can vary from state to state and there might be some unscrupulous factors out there looking to exploit producers and their customers for their own financial gain. The main disadvantages include some of the following:
1. It only fixes the outstanding invoices problem.
Factoring only solves the problem of freeing up cash from outstanding invoices. If you require other forms of business funding factoring can’t help you and you may be better served by a bank loan (for example).
2. It’s expensive.
Factoring is definitely not the cheapest way of doing business, although it can be effective. Factoring seems to be most effective when used by companies that show profit margins which can cover the high cost of factoring.
3. Someone else is now dealing with your customers
This is one of the principal disadvantages of factoring and, coupled with the expensive fees (above) seems to be the main reason some businesses think of it as a last resort.
The problem here is an obvious one: Your business will typically value your relationship with your customers and spend time cultivating that relationship with good service and customer support. Your main aim is to retain your customer for a long time.
When you introduce a factoring company into this picture the relationship can get more complex. The goal of the factoring company is not to help you maintain and cultivate your relationship with your customer, rather, the principal goal of a factor is to get their advance money back from your customers. Your relationship with your customers is not especially important for them and, they have nothing to lose from creating friction in your carefully cultivated customer relationships on the way to getting their money back.
In the process of staying in touch with your customers the factoring company will be required to forward them notice that they are awaiting payment on the invoice and, secondly, they usually contact the customer fairly regularly to ensure that they are satisfied with your services. Not everyone is comfortable with their customers being contacted so regularly and so deliberately by a third party. In many ways, it can detract from your brand and from the relationship you are trying to build with your customers.
How to Vet A Factoring Company
If you are interested in working with a factoring company it is important to do your due diligence on the company you are thinking of using. Most factoring companies will say the same thing about their services and it can be hard to distinguish the better services from the sharks.
Client testimonials are a great place to start with this, to see the experience of others with the company. Don’t just rely on the company’s website for this, check with other people in your industry who have had dealings with factors about who they use and why.
Be sure that the agreement you reach with the factor is tailored to your needs and to your abilities. As pointed out earlier, factoring fees can be high, you need to be sure that you can generate enough of a profit margin to ensure that you can cover these fees.
It goes without saying that before you sign any kind of agreement with a factoring company that you have an experienced attorney look over the details of any contract and advise you plainly on these critical factors:
- Contract duration,
- Notice periods in the contract,
- Contract fees and who is responsible for what,
- Litigation and the litigation procedure,
- Concentrations and how these work in terms of your factor contract,
- Any hidden clauses which may be detrimental to you or your business,
- Automatic renewal of factoring contract,
There are Many Factoring Products & Services
There seems to be many variations of factoring products and services available to the modern business owner. Knowing which of these products provides the best fit and service for their business is the best first step in successfully engaging with a factor to assist your business.
It is important for any business owner to understand how their factor works and if they cover the market you are in. Some key questions your factoring company needs to answer before you contract with them could be:
What are the funding options which they offer to ensure your business can gather the maximum dividend from each invoice to ensure good cash flow through your enterprise?
Do they do credit checking on your customers and if so, how do they do it?
How does the factor plan to introduce themselves to your customers? How do they collect your customer’s information and how frequently do they aim to contact them? Do you want your customers exposed to this kind of contact?
How do they manage your account? Do they use one manager or many? How many clients does each manager deal with daily?
What sort of bad debt protections do they have in place if a client suddenly goes bankrupt or simply stops paying?
Do they have any kind of online accounts system which your business can use to track your account?
What is the cost of factoring with them? Can they justify the expense with good service or are they just after a quick buck?
Does the factoring company specialize in your industry? It is vital that they have experience with how your industry does business and can direct you to the right products to assist you?
Although Spectra is, in no way, offering financial or business advice, we have a good deal of experience in the apparel industry and in working with factors in this space. If you have an apparel business and are thinking about working with a factor to ensure cash flow to your business, why not reach out to one of the Spectra partners – Moe & Brian – they have a great deal of experience in choosing the right factor and might be able to guide your choice of factor with their experience. Contact Brian or Moe if you would like to discuss this