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Invoice Factoring:
Decision Criteria for Selecting a Factor, Part I

Invoice Factoring offers growing businesses a quick, easy way to finance unlimited growth by increasing cash flow and working capital without incurring debt. However, like every good thing, it’s vitally important to understand how accounts receivables factoring really works, and how to avoid its potential pitfalls.

To grow and prosper, every business needs a lot of “green energy” or money. However, a SunTrust Bank 2005 survey of 530 business owners found that because 69% relied on existing cash flow or profits to fund their growth, these businesses failed to realize their full potential.

Factoring accounts receivables, a practice dating back to Roman times, is a proven way for small and sometimes larger businesses to alleviate cash flow problems caused by delays in receiving payments. Invoice Factoring, also known as Accounts Receivable Funding, involves the purchase and sale of accounts receivable (invoices) at a discount for immediate cash.

Unlike a loan, factoring involves no debt, no liabilities, no personal guarantees, and no long-term commitments.

It sounds great, doesn’t it, and it can be -- provided you:

The invoice factoring industry is completely unregulated with few constraints on the people who work in the industry. Caveat emptor (buyer beware) clearly applies in this situation.

This white paper will educate business owners about the potential pitfalls of invoice factoring … and how to avoid them.

Invoice Factoring Pitfall #1 – Working with a factor who you don’t Know, Like and Trust

When you enter into an agreement to factor your invoices, you are in essence inviting a new partner into your business – one that you may not know very well at all. Like any partnership, it’s better to be involved with people with whom you share similar business and personal goals and values. Otherwise, you may be engaged with people that you don’t like, don’t want to know, and can’t trust but who have much potential to harm your business and your customer relationships.

Successful users of invoice factoring take the time to check out the credentials, the business practices and personal ethics of their potential factoring partner, and thereby minimize the potential for considerable frustration, unhappiness and financial hurt. Since you are entering into a three-party deal that involves you, your customers and the factoring company, taking enough time to carry out appropriate “due diligence” is critical. Don’t be shy about asking for customer references and then be sure to talk with 3-5 of the factor’s customers. A good question to ask is, “Knowing what you now know about Company X, would you use them again to factor your invoices?” Listen carefully to the response, and you learn much about your prospective business partner.

Factoring Accounts Receivables Pitfall #2 – Giving the factor too much control over your business

Some factors insist on controlling all communications with your customers concerning your invoices. This gives the factor too much influence over how your customer ends up viewing your company. Most larger companies today are accustomed to working with factoring companies, but they don’t like to be badly treated in the process. A factor’s behavior can put at risk your hard-won relationship with your customer.

In some instances, unethical factoring companies have delayed payments to their clients, thereby causing financial strain and jeopardizing the company. In another instance, a factoring company even tried to gain ownership of its client’s business through unsavory business practices.

Factoring Pitfall #3 – Agreeing to factor all invoices

Some factoring companies insist that all accounts be factored as a way to generate extra fees, or that all of your accounts be run through them even if they are not factored.

By acceding to this, you face the following possible consequences:

Ideally, you should work with a factoring company that offers you flexibility on which invoices you want to factor.

Receivables Factoring Pitfall #4 – Paying a monthly minimum fee

Some factoring companies require that you pay them a specific monthly minimum fee, regardless of the amount you invoice to customers.

For example, if your monthly minimum amount is $50,000, and your actual factored invoices amount to, say $35,000, you would end up paying fees on $15,000 for which you receive no value. Or, if you submit no invoices during the month for factoring, you still end up paying the minimum monthly fee. This is a good deal for the factor, but not for you.

To minimize your factoring fees, do not accept an agreement with a minimum monthly fee component. Ensure that your factoring fee is calculated on the actual amount of your factored invoices.

Business Financial Factoring Pitfall #5 – Accepting excessive clearing days

Clearing days, you might say … what are they?

Essentially, clearing days are those days a bank requires to clear a check. A usual part of a factoring agreement, fees apply during a clearing period. However, clearing periods can vary, and this is what you watch for.

A usual clearing period is 3-7 days, sometimes as much as 10 days. You should avoid anything longer than 5 days.

Some factors use the clearing days period as a way to extend the factoring period into the next “per days period” so they can get more money from you.

In your agreement, seek the fewest number of clearing days, since the shorter the period, the fewer fees you pay. Further, you should seek a factor that does not charge fees on clearing days and terminates all fees the day payment is received from your customer.

Factoring Informational News Articles
Selecting an Invoice Factoring Company: Best Practices, Part I
Selecting an Invoice Factoring Company: Best Practices, Part II
Selecting an Invoice Factoring Company: Best Practices, Part III
View and print entire article pdf format (click below)
Invoice Factoring -  Best Practices for Selecting a Commercial Factor

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