How is that possible.
Well, first of all, you are going to have to pay a factor for their cost of financing, so in that sense its NOT free.
But, depending on the benefit you can gain in your cash flow from factoring, you may be able to reduce or completely eliminate the cost of factoring in with real dollar benefits.
Let me explain.
The scenario where the above will typically play out is in a market where the borrower is reselling goods and services.
Another characteristic of this market is that the primary end customers that drive the overall industry are slow to pay.
An example would be the oil patch where major oil companies (slow payers) are the cash flow stream either directly or indirectly for tier 1, 2, and 3 suppliers.
The credit risk is low overall due to the high credit rating of the main line oil companies, so its not going to be hard to get factoring.
And once you have factoring in place, you can go to your suppliers, who you are now paying in 60 to 120 days, right after the time you get paid from the oil companies, and offer them faster payment in exchange for early payment discounts.
These early payment discounts can be significant and collectively can equal or even exceed the cost of factoring.
So when factoring provides an 85% advance rate at the time of sale and you have a mark up of 25% or better, its easy to see how you can tell your suppliers, or at least main suppliers, that you can pay them in ten days or less if they can provide a big enough discount.
And for many of the vendors servicing this market, they are more than happy to be paid less faster as it greatly improves their cash flow, and cash flow uncertainty as well.
With a proper factoring account, a business can also be set up for growth which means larger annual purchasing from vendors which in turn can lead to even bigger discounts.
So while its easy to say that Factoring is too expensive at 12% to 24% per year, what good is cheaper money if you can’t get enough of it to fund all the sales that are available to you.
In the end, all business financing should be considered on a net effective cost basis.
Put another way, can you put more money in your pockets factoring than not factoring?
Getting hung up on the interest rate is a complete waste of time.
Sure, you should always strive to pay a lower cost of financing, but not if in doing so you are significantly delaying growth, or end up with greater restrictions on use of funds which ends up making you less net dollars.
If you need to work out a working capital financing scenario and would like to see if Factoring could work and its effective cost, then I suggest that you give me a call so we can go through your situation in some detail to see what might work.