How To: Work With a Factor
by Nancy A. Motl,
Ladies Who Launch member, Cleveland
illustration by Barbara Hranilovich
To start, let’s clarify what a “factor” or “factoring” is. Factoring, also known as “accounts receivable financing,” is an alternative form of financing used by businesses large and small. It makes it possible for business owners to secure the working capital they need for growth (and yes, sometimes survival!) without creating new debt.
While factoring has been used for thousands of years, it became very popular in the U.S. garment industry when receivables were not being paid as quickly as companies were receiving orders for more garments. It’s a very flexible financing tool and helps all kinds of businesses meet payroll, take advantage of supplier discounts, or just increase liquidity to maintain growth.
If a business has been turned down for financing by a bank, it can often benefit from factoring for a period of time to make itself bankable. And truth be told, some businesses find factoring so effective that they continue to factor their receivables even when they just need an infusion of cash.
Factoring …
• is NOT a loan—you are NOT incurring debt or giving up equity
• does NOT require years of profitability as traditional loans do
• does NOT take weeks to secure your funding
• does NOT impact the business owner’s personal or business credit
• does NOT require a strong balance sheet
• DOES require invoices to other businesses or government
Ask yourself …
• Would having cash available on demand help you take control of your cash flow?
• Could you increase sales with larger companies if 30- to 60-day terms were offered?
• Would having cash allow you to take your business to the next level?
• Wouldn’t it be great to have a line of credit that grows as your business grows?
If you answered yes to any of these questions, factoring may be the solution. You may already have the cash you need at your fingertips.
A Simple Example of Factoring
A factoring company recognizes an invoice as an asset to purchase, as long as the products or services have been delivered and accepted by the customer. The factor will verify this and an advance is funded to you. Typical funding is 75- 95 percent of the invoiced amount. This can be completed the same day the invoices are received.
The 5-25 percent, called the “reserve,” is held by the factoring company. The reserve is held until the customer pays the invoice. Once the invoice is paid in full, the factoring fee is taken out and the balance is available for withdrawal, or may be held in a reserve account.
Your company factors an invoice for $1,000.00
You are advanced 90 percent or 900.00
10 percent is held in reserve or 100.00
Factoring fee is 3 percent (30.00) *
Balance $70.00
*Fees are based on several variables, including the industry and length of time the invoice goes unpaid.
Today there are factoring companies capable of working with just about any industry, as long as the invoices are B2B or B2G. Industries that use factoring include:
• Apparel or any other manufacturers
• Technical/training consulting
• Staffing agencies
• Trucking
• Commercial janitorial/cleaning services
• Construction
• Railroads
• Cable and wire installers
• Health-care suppliers and providers (medical receivables are handled differently and take a bit longer due to regulations and compliance rules)
Nancy A. Motl is a member of the Cleveland Incubator and the founder of Today’s Funding Solutions.
Oooh…based on 27 years of apparel manufacturing experience, I can definitely say terms and conditions vary according to industry! I don’t know about other industries but the factoring fee in apparel averages 18%-20% of invoice! That is quite a hefty hit to your overhead. If you factor apparel for 3%, boy, can I ever throw you a lot of customers! I know a lot of factors both in the trade and out. The outside factors are usually shocked at the typical factoring rates in the garment industry. However, once I explain the range of services apparel factors offer, they are usually less tempted to take it on.
There’s two kinds of factoring in apparel. One is guaranteed, one is not. I guess there’s still a third kind, mostly regional -a guy who runs around town calling on your stores with a bat in his trunk :).
It’s not just the fee that can make factoring unappealing for people starting a clothing line, it’s conditions too. For example, once you sign with a factor, you must sign over all of your receivables. In other words, if you have clients that have always paid on time and don’t need those factored, you can’t withhold those.
Another element worth mentioning in apparel that may be different from other industries is that apparel factors offer a greater level of services (hence their higher take). Having a factor means you don’t need to service accounts. They do all of that for you so that’s handy if you don’t have the staff to manage it.
Factors also have say-so on which orders you can fill. In other words, they have the right to say who you sell to. Some don’t like that but I think it’s generally a good thing. A new designer starting out has no way of knowing which stores pay their bills. In this respect, factors are credit checking services. Also, guaranteed factoring means you WILL get paid (usually in 45 days) even if the buyer doesn’t pay the factor because they approved the sale.
Generally, a clothing line doesn’t need a factor unless they sell to department stores. There’s other ways to check credit from boutiques (800+ designers networking on fashion-incubator.com for starters). There’s other good reasons not to sell to department stores (chargebacks are nefarious!); I generally don’t recommend it except in unusual and specific circumstances. Selling to department stores means sitting on receivables for six to nine MONTHS! And that’s assuming they don’t scalp you on chargebacks. You must be compliant with their vendor procedures, a whole other animal. This is a whole other level, you can’t mess around. You have to know what you’re doing. Maybe you did fine by hook or crook up to this point but at this level, you can lose it all.
Last of all, if you have a factor, you have to manufacture offshore. There’s no other way to cover those margins. The thing is, the trend in manufacturing (that you’re not reading in the papers, I have boots on the ground) is to produce domestically. Anybody who can find the production slots is moving back to the States. The number one problem of my designers is not sales. Their #1 problem is finding US sewing contractors to fill the orders they have. If anything, they’re turning down orders because they can’t get production. Part of the reason for the increase in domestic manufacturing is that stores want to buy closer to season (offshore means four weeks on the water plus tie-ups at port). The dollar is cheaper (less expensive to produce here as compared to Asia, it’s not as cheap as it once was). Domestic contractors have lower minimums, and lastly, the increasing cost of fossil fuels.
I am in the process of relaunching a clothing line and this article was very helpful. As of now, I haven’t decide how or where my finances are coming from, whether it be a loan or I seek out an angel investor. After reading the comment left by Kathleen I am rethinking factoring. I don’t think it ’s right for me since I’m just starting out. Thank you so much for sharing your knowledge, Kathleen.