Questions to ask a factor…and why

1. July 2009 by admin.

Most people are unfamiliar with factoring, and thus ask the wrong questions.  Yes, fees are important, but they don’t tell the whole story.  Below are some questions you should ask a factoring company when you are analysing your options, and more importantly, the reasons why you should ask.

1.  How long do I have to factor with you?  Factoring contracts are notorious for their “claws” or “handcuffs.”  Most factoring contracts have a term of at least 1 year and prohibit you from switching to another factoring company without paying a large “termination fee.”  Furthermore, contracts typically auto-renew, so a company that is not paying attention could inadvertently sign up for another year of “handcuffs.”

2.  Is there an application fee?  Factoring companies love to charge application fees.  These fees are non-refundable if you choose not to factor with that company.  To some factoring companies, application fees are a revenue generator as they generate a large amount of fees from potential clients even if they have no intention of funding them.

3.  Does the factoring company keep a reserve account?  Reserves are the difference between the payment from your customer and the discount kept by the factoring company.  These funds are technically the client’s money, but many factoring companies don’t pay these back right away.  They may keep a certain percentage to cover any write-offs or other charges or only issue rebates twice a month.

4.  Explain ALL of your fees to me.  Usually, a potential client will call a factoring company and ask for their rates.  The factoring company will usually be more than happy to tell them the discount rate, which is the rate a factor will charge you for using their money.  While this seems straightforward, most of the time it is not.  Let me present an example to assist in understanding. 

If you call up and ask a factor for their rates, they may say 4% for 30 days.  What does this mean?  Nothing, if you don’t know what the advance rate is.  Since the rate charged for factoring is based on the face value of the invoice, a factor that charges 4% with a 70% advance is more expensive than a factor that charges 4% with a 90% advance.  Also, what if the payment arrives in 20 days instead of 30?  Is the rate prorated to only 20 days or must the client still pay for 30 days?  What if the payment arrives on day 31?  Is an additional 4% taken?  How about wiring fees, due diligence fees, monthly monitoring fees, monthly minimum fees.  All these fees and costs need to be fully understood.

5.  Do all payments from customers have to come to the factor?  Many factoring companies require all payments from all customers to come through them, even if you are not receiving funding from those invoices.  This can cause a delay in getting the cash to you.  The best situation is for the factor only to receive payments for the invoices being factored, while the rest of the payments continue to go to the client.

Factoring accounts receivables can be a flexible and straightforward means of business financing.  However, many factoring companies make a living based on unnecessarily complex charges, contracts and fees.  Do your research to make sure you understand the details of your factoring relationship.

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