Business mentor: Factoring in best way to extend growth prospects

Q. My business has grown from $550,000 to $1.5 million sales in three years. As it was started with a small capital base, this has presented various financial challenges, including cashflow pressures.

I now have an opportunity to significantly increase my sales, but this will place even bigger strains on my cashflow because of the time lag between paying for materials, shipping the goods and receiving payment from customers.

My bank is reluctant to increase my overdraft without additional personal security such as my family home.

An Australian customer suggested that factoring would be a great option for me, but I have heard it is expensive and that you lose control of your customers.

What do you think?

A. Small business sector specialist Sarah Trotman replies:

 

There are two main aspects to your question. First and most important, you have an opportunity to further increase your sales but lack capital to fund this growth. Secondly, you are unsure if factoring is the solution.

You don't mention what your terms of business are or whether your customers are paying to your agreed credit terms. For the purpose of this reply, I will assume they are 20th of the month and that most customers pay there or thereabouts, as it would have been difficult to achieve your present growth if this wasn't the case.

Some business owners regard unpaid invoices as a problem. It is, however, vitally important to realise that the debtors' ledger is a current asset of your business. The challenge business owners' face is that it is purely evidence of work having been completed and is not tangible until you are paid.

You simply can't go to a supplier and say, "I've got a $100,000 sitting on my debtors' ledger and I want to buy more dooflickeys".

Factoring speeds your cashflow cycle, enabling you to release cash tied up in unpaid invoices. This means you can borrow 80 per cent to 90 per cent of the face value of the invoice today to exploit the opportunity you have uncovered to increase your sales tomorrow.

There are two main types of factoring. Notified (full service and partnership) and non-notified (confidential and invoice discounting). Most companies in New Zealand use a full-service facility. This means the factoring company looks after your accounts receivable ledger, sends statements and provides a comprehensive range of reports regarding the collection of accounts.

In answer to your concern about the expense of factoring, there is an interest charge on funds drawn down that is comparable with a bank overdraft. Depending on the bank's security, I have seen occasions where the factoring company's interest rate is more competitive.

There is also an administration charge calculated against the face value of the invoice. This can be 1.5 per cent plus or minus depending on level of turnover, number of invoices and debtors and the type of facility offered.

Remember that you are receiving a service for this charge and it may mean that you can spend more time getting out and growing your business instead of chasing old debt, or alternatively, not having to employ someone to do it.

You also mentioned that you may lose control of your customers. Control remains with you. You still control pricing, invoicing, dispute resolution, your credit policy and with whom you deal.

Some would argue you have more control, as you are receiving payment up front for outstanding invoices, allowing you to pay suppliers on time and/or negotiate early payment discounts, giving you control of your cashflow.

When considering a financier, consider how well established they are, how financially strong and what other products and services they may be able to offer. Are they relationship-driven? Can you view your account over the internet?

It is interesting that one of your Australian clients suggested factoring. I had an interesting conversation about factoring at the ORIX stand at the recent Business Expo in Melbourne.

Across the Tasman, factoring has increased from A$2.5 billion to A$25 billion a year in the past 10 years. Although we Kiwis pride ourselves on our ingenuity, we're a bit slow and, at times, conservative about the take-up of new financial products and ideas. It wasn't too long ago that leasing a car was considered a concept for "people who had rocks in their head".

Factoring is not a rocks-in-the-head option, and being a former credit manager/debt collector, I can assure you of this. It can provide your business with the working capital it needs to exploit new opportunities and grow.

* For more information on factoring in New Zealand, contact Brett Mihaljevich, business finance manager for ORIX New Zealand, on 09 520 9723.

* Email your small business questions to georgina.bond @nzherald.co.nz Answers are courtesy of Sarah Trotman, sarah.trotman@spring.co.nz