Factoring isn't borrowing money, it's selling your receivables for cash.  It's a more expensive way of raising money than normal financing, but provides quick cash on no collateral or earnings.

Financing monthly receivables of $100,000 would cost about $12,000 in yearly interest through a conventional line of credit -- if you qualify. Factoring those same receivables could cost anywhere from $36,000 to $60,000 a year.

But for many entrepreneurs factoring makes sense as a first step.  Take the case of Slim and Jim, who make and sell scarecrows.  They've found a couple investors who'll foot start-up materials, a patent search and patent application.  But they need cash for materials, and to keep up with their orders.  Waiting 30 days for payment isn't feasible -- it's a shoestring operation.

An uncle puts them in touch with Gil Bates, a golfing buddy who's a factor.  Bates visits Slim and Jim's operation, evaluates their retail customers, and agrees to factor their receivables.

Slim types up the invoices and sends them to Bates's office in Pasadena.  Bates then enters the billing amounts in his bookkeeping system, stamps the invoices payable to Gil Bates, and sends them on.  He then writes Slim and Jim a check for 75 percent of the invoice total.  He'll send 20 percent more after collection, and pocket 5 percent.

Slim and Jim have a good month in August, forwarding $20,000 worth of invoices to Bates. Two days later they receive $15,000. They get $4,000 later that month.

If Slim and Jim's customers pay 31 to 60 days after billing Bates collects 7 percent of the profit.  Up to 90 days Bates receives 9 percent of the collected funds, and if it's still delinquent after 90 days Slim and Jim buy it back.

Are they happy with this arrangement?  Ecstatic. Bates charges a lot, but he also provides complete credit checking of all customers, sends Slim biweekly updates on each customer's payment history, and badgers slow-paying customers. Bates has also introduced them to potential customers, and when Slim and Jim are ready, he'll help them make a transition to bank financing.

Slim and Jim aren't getting rich with this arrangement, but the way they see it, they probably wouldn't be in business for themselves at all -- if not for factoring their receivables.  More sophisticated financing is down the road, the road factoring helped put them on in the first place.

Article Copyright Enterprise Interactive