Is Your Factoring Company Well Capitalized?

Is your factoring company profitable and well capitalized? Better hope so.

With so many factoring options available, how do you know which factoring company is the best fit? On the surface, it may appear to be an unimportant decision; after all, money is money. But the reality is that now more than ever, the financial future of your family and your business rests with making the right choice.

The most important piece of information you can get from your prospective factoring company is how it is funded and who’s making crucial financial decisions. Factoring companies are largely unregulated private companies that suffer the same rate of failure as businesses in general. Most factoring companies rely on borrowed funds and outside investors to finance their ongoing purchase of clients’ accounts receivable. Like many other borrowers since 2008, factoring companies have seen the availability of credit retract or even disappear. Your factoring company’s access to capital is now as important as your own.

Factoring companies that rely heavily on borrowed funds and outside investors as their primary source of capital are subject to the demands of those lenders and investors. For example, a lender might restrict how much credit it may approve for a factoring company’s customers. Likewise, outside investors may unexpectedly pull their funding without notice, leaving the factoring company unable to support its customers— or worse.

When it comes to the stability of a factoring company, the less borrowing, the better. One key measure of the soundness of your factoring company’s balance sheet is its debt-to-equity ratio— that is, the comparison of how much they borrow relative to their net worth. Some factoring companies borrow five or more times their net worth. And because they are not required to maintain any capital, theoretically, factoring companies could borrow all their necessary funding. The more reliant your factoring company is on borrowed funds, the more risk is passed on to you.

To avoid any potential financial pitfalls, seek out a factoring company that has a long track record of solid business practices, one that has built up its retained earnings and that uses primarily its own capital to fund its operations. The stronger its capital base, the better your factoring company can withstand economic uncertainty. The less reliant your factoring company is on investors, the better your chances of receiving quick responses to your requests.

In 2008, several factoring companies closed their doors, including GE Capital Transportation Finance and Textron Financial, among others. In some cases, parent organizations no longer saw factoring as an important part of their business. In others, factoring companies were simply not profitable to shareholders. A good rule of thumb is to do business with a factoring company that IS a factoring company— not a bank or a manufacturer of aviation products or a subsidiary of an international conglomerate.

Usually, managers of a good factoring company will be entrepreneurs, like you. In some cases, you can have direct access to the owner of the factoring company, who can make decisions for you at the drop of a hat. The larger the organization, the less likely it is you will receive the attention you deserve.

Although you want to remain a priority for your factoring company, it is also important to ensure that you are not its largest account. If your business represents more than 5% of your factoring company’s volume, be cautious. On the other hand, if your factoring company’s sweet spot is $1 million and you wish to factor only $10,000 per month, the level of customer service your receive is likely to suffer.

Author: Tony Furman
Copyright 2009
Interstate Capital Corp.

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