Myth Buster: Factoring Is Too Expensive?

By Tom Klausen

One of the many myths surrounding the factoring industry is that factoring is simply too expensive to be considered a viable commercial financing option for the average small business. The biggest mistake with this thinking is that more attention is paid to calculating a factoring “interest rate” rather than answering the simple question, “Will factoring work?”

Most people don’t realize it, but factoring is the most widely used form of financing in the world if you consider that the major credit card companies (Visa, MasterCard and American Express) are essentially factoring companies. The merchant fees they charge to retailers (usually between 1-4 percent of the transaction) are very similar to what is charged by a commercial factor in a net-30 transaction. Most retailers would soon be out of business if they stopped accepting credit cards simply because it was “too expensive.”

Put It In Perspective: When someone tells me they think factoring is expensive, I ask them “compared to what?” Granted, factoring is more expensive than the interest rate charged by a bank on a traditional line of credit. But nowadays, many small businesses don’t qualify for a line of credit adequate to meet all of their financing needs. A line of credit, after all, is not a right, but a privilege. If you have one, then be thankful and use it wisely. But if you don’t, then you should seriously look at the next best alternative: factoring.

Sometimes, misinformation about factoring comes from financial professionals, which is unfortunate. Rather than factor, I have seen companies go out of business, pass up large orders, break promises to suppliers, and welcome strangers as partners. It is my contention that these options are far more expensive than factoring.

Usually, the least expensive option is not the best one. In the end, the cheapest solution often costs more because it did not solve the problem. For example, what good is a line of credit if it is not adequate to meet the cash flow needs of the business? Factoring allows a business to grow quickly and build strong supplier relationships while freeing up the principals to focus on sales and profitability. It’s hard to attach a percentage rate to these benefits, but if you did, it would be significant.

A good factoring company also provides a host of valuable back-office services, including credit checks, posting and ledgering of payments, and professional A/R management. A full-service factor essentially becomes the business’s full-time credit manager, performing all the services of a full-fledged A/R department. There is obviously a cost savings to that.

True Cost of Factoring: So, is factoring really that “expensive”? On the surface, it’s more expensive than a traditional bank line of credit, but it’s a lot less expensive than the other options.

Here’s the point: If your company is in need of commercial financing, don’t be misled by common myths about how expensive factoring supposedly is. Consider all the components of the equation and all the potential alternatives before you decide whether or not factoring is worth the higher cost.

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