For years now, you could sell your Accounts Receivable to “factor” companies. These companies paid cash for your accounts receivable less a discount factor for providing the collection service (hence the name).
The reason business owners chose to use a factor company was simple — cash. Rather than having to wait weeks to collect the cash from receivables, owners received immediate cash. This cash was not without a price, however. Typically, the premium paid to get this immediate influx of money was far in excess of what it would cost in traditional bank-line interest to collect those receivables in-house. And, because the factor company was the one billing the customer and whose name was apparent on the bill, there often was a stigma of financial distress associated with the company that had sold those receivables. Traditionally, therefore, the only businesses who sold their receivables to factor companies were those that could not get bank lines.
Today, reputable banks have entered the receivables-buying market. Why? As banks post record profits and are flush with cash, they are seeking new, high-profit ways to invest that cash. Unwary business owners may assume selling receivables is a good idea simply because their bank is making the offer. Selling off receivables, however, may not be the best economic choice.
One Meridian client was solicited by his midwest bank with an offer to purchase his receivables less a fee of 3.9% (the discount rate). With $12 million in annual credit sales, this reader’s cost to sell his receivables to his bank would be $468,000 annually! Ouch! With a bank line at 10% interest, he could have $4,680,000 outstanding on his line of credit before paying the same dollars to the bank!
In reality, a $12 million company typically has $650,000 of receivables (19 days). Even if we double that amount to $1,300,000, the annual cost to borrow the entire receivables balance constantly on a line of credit would be $130,000, or about one-fourth the discount factor cost! Add in collections labor and materials and you are still way ahead borrowing on a bank line.
In most instances, carrying and collecting receivables is more cost effective than selling those receivables to a bank or factor company. Until banks become competitively priced on this service (which could happen, but, don’t hold your breath), collect your own accounts.
