Factoring? Be Smart, Know Your EFFECTIVE Rate!

By: Kenneth P. Walsleben
Date: 7/1/2008

Are you presently factoring, or thinking of factoring your receivables? If so, great! I won't try to dissuade you. After all, my firm is a factoring firm and I believe whole-heartedly in the numerous benefits of our services. Many a business has flourished because of the timely cash flow assistance delivered by factors.

Luckily for you, I'm going to save you money. Lots of it. I want to educate you and turn you into a smarter consumer of factoring. Personally, I prefer smart consumers of our service. Smart consumers usually make good decisions about who they wish to work with.

Like many financiers, factors quote a 'rate', but then there is a true effective cost of that capital. They aren't the same and that, by itself, isn't unusual. After all, if you read the fine print of an advertisement for a bank loan or mortgage, you'll see terms like "rate" and "yield" for the same loan. Often, the yield is a smidge higher, but unless there are substantial loan origination points involved, the difference between "rate" and 'yield" is usually negligible.

However, there is sometimes a large difference between what you think you're paying (rate) and what you're actually paying (effective cost). Funding companies (and by extension, many factors) have become expert at disguising the true cost of their capital. I guarantee that every time a current user of factoring tells me about their "great rate", I can stop them in their tracks if I ask them what their true effective rate is. Inevitably my question is met with abject silence. Sometimes there's even a slight sucking sound! The more forthright folks may actually admit they have no idea about what I'm asking, or they'll flat out concede that they have no idea.

If you don't know the answer either, take heart.You're not alone.

Here's the issue: funders of all stripes (not just factors) can dramatically enhance their program yields (i.e., effective rates) through transactional structuring. Here are some examples of yield enhancers for factors: term agreements, minimum monthly fees, fee periods longer than 10 days, minimum fee periods, volume requirements and associated penalty requirements, reserve escrow accounts, fee float days, blanket assignments of all accounts (whether factored or not), treatment of non-factored invoices, clever tack-on fees for item processing or electronic transfers, requirements that all invoices be factored or that all be factored at once without the option of aging prior to factoring, and finally, batch accounting rather than individual invoice accounting.

I'm betting that if you're funding your receivables, you're dealing with at least a few of these items. Wouldn't it be great if you didn't have to deal with these buried costs? Wouldn't it be refreshing if your factor confirmed that your stated rate was equal to your effective rate? If you are dealing with any of the items listed above, I can confirm that your actual effective cost of capital is higher than you've previously thought.

If you'd like to obtain a listing of these hidden yield enhancers, contact me as described below. We can help you to compare. It may prove to be impossible to calculate an exact answer, but we can help you to better determine your actual effective costs of capital. Only then can you properly compare the bids of competing suitors. We try to ensure that our stated rate equals our effective rate. I challenge you to ask your present funder about these issues. See what sounds come over your phone when you ask him/her what the effective rate of their program really is. I'm betting that you too will become a wiser consumer!

Ken Walsleben is a Principal of The Hamilton Group. He can be reached at 800.351.3066 or ken@hamiltongroup. net. Hamilton can be found at www.hamiltongroup. net