When prospective factoring clients compare factoring to automobile or mortgage lending rates, factoring initially appears expensive. Prospective clients tend to annualize the points charged, equating 3% per month to an interest rate of 36%. This is both an incomplete and incorrect comparison. First, factors purchase accounts receivable at a discount. They do not lend money. The paper is short-term in nature and management intensive versus a bank loan, which is secured against some stable asset and usually advanced once. Factors are continuously advancing and collecting accounts receivable, providing clients with ongoing reports, credit due diligence, and personalized account management services.
When prospects make this comparison, we ask them to look at the amount they offer for early payment. If the standard 2% discount for payment within 10 days is annualized using the thirty-six 10 day periods in a year, they have lost 72% interest.
Are they really losing 72% for early payment? Of course not…It is more appropriate to look at the opportunity cost of the funds. If the funds cost 3% per month and you can take them and generate more than a 3% return or save more than 3%, then factoring may be the best alternative. What amount of return is generated when a company has an order but no way to fill it? The answer is none. How much return does a $35.00 overdraft fee generate?
A business must weigh the costs of factoring against not having the immediate cash flow. Most often the choice is between factoring and putting up with severe cash flow problems and missed sales opportunities.
