Accountants Should Understand and Recommend Factoring

One of the toughest obstacles to overcome when trying to recommend the business finance solution called factoring, very often is the businesses accountant. The business owner begins to consider this finance facility and unfortunately the accountant will encourage his client not to use it.

Where is the objection? The accountant does some quick math and determines that the proposal sent by the factor indicating a factoring discount fee of 3% per month is an annual interest rate of 36%. Nothing can be further from the truth. Factoring loosely defined is the sale of invoices at a discount to a finance company called a factor. Note the definition says nothing about loan, interest, APR or any other verbiage associated with lending. The finance contract itself is not called a loan agreement but rather a “master purchase and sale” agreement. So the mistake is equating the discount fee to an interest rate.

The discount fee is a reduction in revenue from sales. Suppose a business gave its customers a 2% discount for paying in 10 days, is that a 72% interest rate equivalent? (2% X 3 ten day periods X 12 months = 72% interest rate??). Of course not. It is recognized on the books of the business as a 2% discount given to customers for early pay. So it is with factoring. The 3% discount that a business may pay on factoring (for early receipt of the invoice payment this time provided by the factor not the debtor) is exactly that, and it cannot and should not be an annualized interest rate.

Accountants bring real value to the factoring proposal by advising his/her client if the discount can be absorbed by the businesses net margin. One should consider factoring as a temporary equity partner participating in the profits for 3%, 4% etc.. Once the factoring business has grown to the next level then traditional less expensive finance options open.

CPA’s can help their clients by appreciating the nature of factoring and evaluating if it is a viable and affordable option.