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The Dangers Of Accounts Receivable Loans

January 8th, 2009 · No Comments

Driving home one night I heard a commercial on the radio for a company that offers accounts receivable funding.  It is designed for small businesses who have cash flow issues and want to collect their money instantly.  This intrigued me since I am a small business owner.  The ad went on to say you should not “waste your time collecting bills” so that you could “focus on selling.”  Sounds fair enough, right?  Aren’t sales the key to any business staying in business?  I then went home to research this further.  Could these businesses be better than banks at loaning money?  Whatever that means. Here is more elaboration on the benefits of choosing an accounts receivable funding firm than choosing a tradional bank:

Accounts receivable funding firm:

We will help you if your business is…..Fast Growth, Startup, Financial Loss, Seasonal.   (sounds like companies with a solid future to me!)

We offer unlimited A/R funding, No Financial Covents, Advances Up To 90%, Free Credit Checks

Our approval process has NO financial statements needs, NO dependency on personal credit, NO normal three years of tax records, NO lengthy approval process, NO denial for IRS problems, NO denial for tax liens.  (sounds like they don’t say NO to anybody!)

Now, of course they paint traditonal banks as the enemies of small businesses with all of their requirements, paperwork, risk assessment, yada yada yada.  

So, let me summarize:  Accounts receivable funding firms apparently will loan money to anyone who claims to own a business.  A quote from Wikipedia’s definition of this practice (called factoring) says this:

Factoring is a method used by a firm to obtain Cash when the available Cash Balance held by the firm is insufficient to meet current obligations and accommodate its other cash needs.

A method to obtain cash when the cash balance is insufficient to meet current obligations.  Well, yeah.  That’s pretty much what a loan is, no?  A loan is what you get when you have no money.  Duh.  But here’s the rub with the firms that offer this “factoring” or accounts receivable loans.  The fee structure is exorbitant.  They take 10% (or more) right off the top of your outstanding accounts receivable.  Then they pay you back the the remaining 10% based on how much they collect from your debtors.  Less any of their fees, of course.  Now, what’s the incentive for the factoring company to lower that 10% to 8% or 5%?  If I’m the owner of that factoring company, I’m thinking “um, we tried to collect from your clients but they were down on hard times.  We weren’t able to collect back that 10%.”  These folks get a 10% return on their loan to you nearly right off the bat.  

But wait, it gets better.  The Wikipedia article goes on to say that the risks of this industry include fake invoices (by the loan applicant), direct payments to the loan applicant from his customers (without telling the factor company) and clients being billed twice (once by factor company and once by original debtee).  This sounds like a recipe for disaster to your business.  

What is the solution to this need for cash by small businesses?  It’s the exact same one I’ve preached to you on this blog for years – keep large amounts of cash in the bank.  If you want to stack the odds of business success in your favor, pay cash for as much as possible and stay away from these awful loans.

Tags: Money

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