Beware of Factoring your Accounts Receivables and other Credit Card Type Lending Products

loan financingIn these difficult economic times, it is quite difficult to obtain financing. Most traditional sources of lending have just about stopped lending altogether. The few traditional loans I have seen in the commercial markets recently have been real estate loans where the loan to value was less than fifty percent, and the lender required a substantial cash balance to be kept in their bank. And under those circumstances, why would you need a loan in the first place?
We, at Accounting Solutions Ltd., have been protecting our clients from bad financing and other cash management mistakes for the past 27 years. Recently, we have seen many new customers coming to us with these problems, so we wanted to alert all of you to these dangers. The following examples should help you. If you are facing any of these dangers, please give us a call. We have many solutions that we have developed over the years, that can help you properly manage your resources.
The Horrors of Factoring
Let’s say you are having cash flow difficulties. You need financing, and no one is offering a Line of Credit. You open your mail, see a factoring offer, and it doesn’t sound too bad. They offer to factor 80% of your receivables for a 2% fee and a 12% annual interest rate. All of the other financing you are looking at are Hard Money Loans charging 5 points and 18% interest. You figure that paying a 2% fee and 12% interest is less, so you go for it.
The mistake that you made is that you did not account for the concept of time. So let me take you through this example. You have an average receivable of $50,000 per month, and figure that having someone else collect your debts will save you $5,000 annually in your time. What is the Annual Percentage Rate being charged on this financing?
First they are charging a 2% fee every month on all of your receivables even though they are only lending on 80% of them. So 2% of $50,000 is $1,000 per month or $12,000 per year. Next they are charging 12% annually on the amount lent or 1% per month on $40,000. That’s $400 monthly or $4,800 per year.
Their total fees annually are $16,800. You are saving $5,000 per year, so it is costing you $11,800 to finance $40,000. Your Annualized Percentage Rate is 29.5%. You would have been better off with the Hard Money Lender at 18% and 5 points.
Going into these deals, no one seems to do the math.
Credit Card Financing
This is some of the most expensive financing that I have every seen. These lenders, if you want to call them that, have a tendency to prey on restaurants and other entrepreneurs that collect their fees mostly through the use of credit cards. The terms vary from deal to deal. But they will advance money and charge fees and interest similar to a Receivables Factor. The difference is that there is no collections process. You are saving no money to have someone else collect your fees. They simply automatically take it out of your credit card proceeds. When you do the math, and it’s generally the same sort of math, those APR’s end up even higher then most receivables factors.
This can be the sort of financing that will put you out of business.
The proper management of cash is one the keys to successful business management. You need to rely on your accountant to help you with your financing needs. If you do not have one who can help, then you should change accountants. The professionals at Accounting Solutions Ltd., have been helping clients like you properly manage their resources for years. Please give us a call for a complimentary consultation.