What is factoring?
Factoring, commonly known as accounts receivable financing, is when a business sells its invoices to a “factor” for instant cash.
Many people want to compare factoring to using a credit card to charge business expenses. There is no comparison between factoring and using a credit card. However, there is a valid comparison between factoring and accepting a credit card.
When you set up a merchant account to accept credit cards, you agree to pay a merchant fee for the service. This fee is a percentage of the face value of the sale. You are, in essence, granting your customer credit terms (depending on their agreement with their credit card company), and you are receiving the money in your bank account 24-48 hours later, for a fee. That is the factoring relationship.
In order to be competitive in today’s business environment, you have to grant credit terms to your customers. However, you also have to pay your bills in real-time. When you sign on with LDI Growth Partners, and you sell us an invoice, we put the money in your bank within 24-48 hours. We charge a fee for this service, based on the face value of the sale, or invoice amount, and the amount of time the invoice is outstanding. We then work with you to ensure your customer pays on time, just like the credit card company does.
Perception vs. Reality
There are some common misconceptions about factoring that cause confusion or misrepresentation. Here are some common perceptions that we’d like to clarify.
Perception: Fee is time driven. Slow pay invoices “cost” more
Reality: Payment cycles often shorten which results in a lower cost.
Perception: My customers will be upset by the involvement of a third party
Reality: We are an extension of your office and are mindful of your customer relationship.
Perception: “I won’t be in control of my business or my money”
Reality: We do not have minimums and do not require our customers to factor every invoice every time. Our service is a tool for you to utilize to increase your cash flow on an “as needed” basis.
Perception: It is less expensive to use a personal credit card or refinance my house
Reality: Factoring is NOT a credit line. When we purchase an invoice, we are buying an asset of your business at a slightly discounted rate. The payment source we depend on is your customer. There are no minimum monthly payments on a debt.
Perception: The interest rate is high
Reality: Factors do not charge interest. You are discounting the face value of your invoice in order to get cash now.
Perception: “I have a relationship with my bank” or “ I don’t want to change banks”
Reality: LDI Growth Partners is not a bank. We are a private factoring firm. We will partner with your bank and other finance professionals to ensure that you receive the best advice and service.
Perception: My customers will be angry if we use this service?
Reality: Not true, although this is one of the most common misconceptions that we hear. We operate as an extension of your office. We are extremely mindful of your customer relationships and work with you and your customers in order to improve your bottom line.
Perception: Factors “take over” the cash management of its clients?
Reality: Not true. Our goal is to help you grow your business, not run your business. At LDI Growth Partners, we do not set minimums for our clients, nor do we require our clients to factor all of their invoices. You are the expert in your business. You determine when you need cash, and you determine when you want to factor your invoices.
Most businesses can benefit from factoring. You can turn an asset into instant cash, thereby creating much needed cash flow to operate the business. Increased cash flow can help a growing business to do things like:
- Take advantage of vendor discounts
- Buy equipment
- Reduce stress
- Meet payroll or other working capital needs
Factoring is “off balance sheet financing”. In other words, factoring does not create debt for the business. When an invoice is sold, it immediately converts from a non-cash asset to a cash asset on the business balance sheet. There is no bank line or credit line reported to any credit agency. The factoring relationship does not affect credit scores or debt-to-income ratios.
Use the cash generated to:
- Take Advantage of Growth Opportunities
- Re-Stock Inventory
- Fill Pending Purchase Orders
- Meet Payroll
- Pay Taxes on Time
- Address Periodic or Seasonal Cash Flow Problems
What are other advantages of factoring with LDI?
LDI Growth Partners acts as extension of your AR department. We provide credit reviews of all customers and we process the accounting for the customers that we factor for you. In addition, we can review credit for customers that you are considering doing business with so that you can make an informed decision.
- Invoices paid in real time (funding on approved invoices within 24-48 hours)
- Back office receivables management at no extra cost
- Credit review performed on all new customers by credit professionals
- No debt on the balance sheet
- Credit facility does not show on your credit report (does not affect debt ratio)
- Time savings to you – you can spend your time on your business
Cost of factoring
The “cost” of factoring comes with much debate over cost versus price. The price is an easy question to answer. Fees are charged for the service based on amount of time an invoice is outstanding. The average fee is 3-4% of the face amount of the invoice (assuming the invoice is paid in the 30-45 day range). The longer an invoice is outstanding, the higher the fee. The cost is a very different question. A more appropriate question might be: What is the cost to NOT factor.
For many business owners, one of the greatest sources of stress is wondering when the money is going to come in for work that was done 30-45-60 days prior. How do you determine the “cost” of that stress? With factoring, the business owner knows exactly when the invoice is going to be paid. It will be paid 24-48 hours after being submitted to the factoring company and qualified for purchase.
Factoring is really an easy process. Here are the steps to selling your unpaid invoices. LDI will always help you every step of the way.
2. Get approved
3. Submit invoices
4. LDI reviews invoices and credit history
5. LDI electronically transfers money to your bank for your invoices