Factoring company can help cash flow

Factoring company can help cash flow

When Sandy Dykes founded Quality Care and Rehab in 1993, he hit the ground running with three employees; by 1996, Dykes had 600 people on the payroll of his company, which provides speech, occupational and physical therapy mostly in the acute skills units of client nursing homes.

But Quality Care’s fast start was also nearly its undoing. A year into its existence, Quality Care hit major cash flow snags, as payments from clients lagged behind deadlines for a burgeoning payroll and other expenses.

The cash crunch hit its nadir in 1994, when Dykes said the company “nearly grew itself out of business.”

The problem was essentially one of timing. About 50 percent of the company’s receivables came in within 30 days. The remaining receivables normally took between 60 and 90 days to come in.

“Everybody likes to ride you for a little while,” said Dykes.

As a nascent enterprise with little in the way of tangible assets, traditional bank financing wasn’t an option.

The answer to Dykes’ cash-flow woes came at the suggestion of his accountant, who advised he consult a factoring company, which would allow him to use his outstanding receivables as collateral to gain access to cash.

Specifically, Dykes’ accountant recommended he contact Baton Rouge-based Commercial Capital Management, the state’s largest Louisiana-based factoring company.

Dykes had never heard of factoring at the time. Today, he says, “we would have gone out of business without them.”

The quiet company

Last year, Commercial Capital financed an estimated $200 million in accounts receivables. This year, the total could reach about $300 million.

The 7-year-old company has been quietly expanding its regional operations, opening offices in Lafayette and New Orleans over the past couple of years. Later this spring, the Baton Rouge headquarters will move from Drusilla Lane to a larger Industriplex facility. The company will also open offices in Jackson, Miss., and Mobile, Ala., this year.

Although factoring has been around for hundreds of years, the concept is generally little known in Louisiana, where the practice has only been permitted since the state adopted the Uniform Commercial Code less than a decade ago.

While little known, the concept is straightforward: The factoring company purchases a clients accounts receivables and then advances cash based on the face value of individual invoices. Typically, the cash advance represents 70 percent to 80 percent of the cash value of an invoice.

In Commercial Capital’s case, client companies receive the cash advance about 24 hours after their invoices have been submitted and substantiated by the company.

When the invoices are paid, payment goes to a locked box at a bank. At that point, the factoring company recoups the amount of the cash advance in addition to a percentage of the receivable’s value as its fee for services.

At Commercial Capital, that fee, known as a discount, is typically 2.5 percent, said Pat Haney, president and one of the company’s four partners.

A fee of 2.5 percent would mean that for a $750 cash advance on a receivable with a face value of $1,000, Commercial Capital’s client would pay $25, or 2.5 percent of the invoice amount.

Although 2.5 percent is a standard fee for Commercial Capital’s services, the fee varies from as little as 1.5 percent to as much as 4 percent of a receivable-s value. depending in large part on the creditworthiness of the client’s customers.

Risk factors

An integral part of factoring is assessing how likely it is that a client’s customers will eventually pay their bills. The customer’s customers are therefore key to the factor’s lending decisions, which are made on an invoice-by-invoice basis.

Banks are normally ill-equipped to track a company’s operations on such an intensive basis, Haney said.

Because of the key role played by the client’s customers, Commercial Capital generally advances cash to clients whose customers are mostly larger companies with established track records for paying their debts.

However, doing business exclusively with well-known firms is not an absolute requirement, Haney said.

That’s because part of the company’s due diligence process is evaluating who its clients do business for and whether those clients make timely payments, Haney said.

In order to make that determination, Commercial Capital requires its applicants to submit a detailed history of past transactions involving each company for whom a receivable is submitted.

Commercial Capital also uses business resources such as Dun & Bradstreet to verify that its clients’ customers are established entities.

The advantages of a factor to a startup enterprise or fast-growing company are several, say factoring’s boosters.

The application is fast and straightforward. Commercial Capital, for instance, requires a two-page application. along with the invoices and related billing histories.

For companies for whom bank financing is not an option, factoring provides access to cash without having to dilute equity ownership by taking on additional partners, said Louisiana State University banking professor Willie Staats, himself involved in a new Baton Rouge factoring enterprise, Seven Oaks Capital Corp.

Despite the advantages, factoring has its critics, chiefly those who say its fees are too high.

That criticism has dimmed over the past few years, however, as factoring has gained in popularity and a growing number of banks have gotten into the factoring business.

“It has gained acceptance because it works,” said Staats.

For a company without a strong credit history, factoring is sometimes less expensive, said Lynn Juban, president of Fidelity Bank & Trust, who regularly refers clients to Commercial Capital.

“Sometimes a company needs to leverage their receivables more than a traditional bank would feel comfortable doing,” said Juban.

While typically viewed as a temporary alternative to low-interest hank financing, Haney said, some of his company’s clients have taken a long-term view of the company’s services, even though they have established their own track records and would easily qualify for bank financing.

Dykes, of Quality Care, is among those who have grown comfortable with the practice. He said he is in no hurry to wean his company from Commercial Capital’s services, although he concedes he uses its services less than he used to.

“There’s some loyalty there,” he said. “They were there when no one else was.”

Copyright Baton Rouge Business Report Mar 17, 1998

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