David Estrakh, Express Trade Capital
Unforeseen Costs. Like any financing arrangement, factoring can come with unforeseen fees and high reserve requirements. Be sure to carefully read your factoring term sheets and agreements before you sign them. Factoring is labor intensive and time consuming, not to mention, risky, so expect to pay for the service. Although interest on factoring loans are more expensive than banks, you should still shop around to make sure you get reasonable market rates.
High Minimums. Most factors have monthly and/or annual minimums to cover overhead and ensure consistent sales, which can be difficult if everyone is not on the same page regarding expectations. If you sign up with a factor and do not like the relationship, you may not be able to terminate without paying off the minimum commitment. It is therefore important to make sure that the minimum is not so onerous that leaving early becomes too costly. Otherwise, you may be stuck in an unwanted relationship.
Bad Credit Accounts. Factors look at customers’ credit in order to determine the risk of advancing funds on receivables to be paid by that customer. This is an advantage for clients because they can know the credit of their customers in advance, before shipping goods to them. Unfortunately, a customer with bad credit can make things difficult when you’re factoring their receivables. If a customer has a history of late payments or delinquency, that customer’s orders may not eligible for funding.
Many factors will still advance funds against non-approved receivables, especially if those receivables are bundled with credit-worthy accounts. But the client must be aware that the risk of non-payment on non-credit-approved receivables falls to them; such receivables are with recourse to the client. Amounts advanced on poor credit receivables are usually less than what is advanced against credit approved receivables – often up to 60% instead of 80%. But this is not always the case and many factors will simply refuse to factor receivables from accounts with bad credit.
It is important to note that different factors treat bad credit accounts differently and factors may look at the same customers differently. For example, one factor might approve an account that another factor will not, although most factors will make similar credit decisions when presented with the same customer information. The reasons for a bad credit determination will also affect how much, if any, advances the factor is willing to make. When these instances arise, tread carefully, heed the advice of your factor, and handle all poor credit accounts on a case by case basis.
Choosing the Right Factor. Let’s be honest, every industry has unscrupulous and unethical business people who give the others a bad name. Factoring is no different. Factoring is, at its core, a relationship. Once engaged, factors (especially those who also provide purchase order funding) control the levers of cash flow for their clients. Flexibility, speed, and understanding are paramount for a successful factoring and lending relationship.
The above is a segment from our upcoming white paper, Factoring Basics, keep an eye out for the full piece coming soon!
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