The Truth About Business Factoring and the Real Factor Cost of AR Finance in Canada

Updated: February 21, 2011

Your firms ability get financing around the most liquid and accessible business asset you have, your receivables, is what can make or break many small and medium sized businesses. The big corporations seems to have this down quite well already , as they have large sophisticated infrastructures for credit and collections, as well as access to corporate borrowing and securitization facilities that smaller companies just don't have .

But you still have access to business factoring - all we can warn you about is that it's important to understand your true cost - (it's not what you think it is!) and, even as critical - picking your partner in this method of Canadian business financing.

Is your firm eligible for a business factor facility? If you can answer yes to one single question - 'Do you have accounts receivable?' then, you guessed it, you're eligible! In many cases if you are working with the right firm you can blend in receivable and purchase order financing into the same facility - the names tend to change then, as we refer to that as asset based lines of credit and working capital facilities.

So, it's always about cost, right? We don't think so, but our client's sure do, so let's invest some time to discuss the real factor cost of ar financing in Canada. Part of the problem in addressing the cost issue is the perception by clients, totally understood of course, that factoring costs are viewed as interest rates by the borrowers.

That's not how the industry views it; they are buying something you are selling, at a discount. That discount rate is often (99% of the time!) interpreted as an annual interest rate. So while the factor firm buys your receivables at a rate of between 1-3% (on a monthly basis) our clients gasp and view that as 12 - 36% annual percentage rates.

So, how do you assess the factor cost then? Here are the elements you should consider in assessing business factoring in Canada. First of all, if you don't have some decent gross margins on your products or services then even bank financing or carrying your own receivables is expensive. So a solid gross margin is important.

To calculate your margins of course simply take your gross income and divide that number by your sales revenue and express it as a percentage. The number of course shows you how much you are making considering the costs you incur in actually producing that product. Naturally service companies have usually great margins, because there is no direct cost of sales.

Other issues to consider in understanding the true cost of factoring is how long it takes to collect your receivables, as well as the actual cost it is taking you to carry that investment. And don't forget the concept of lost opportunity - you can take you factoring cash and turn that into additional sales and profits, as opposed to waiting for a cheque to come in 60- 90 days later.

Our final point is that the cost of factoring can be significantly offset by your ability to take discounts and purchase in a smarter fashion, in quantity, etc.

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