A Key Factor For Business Health is Liquidity.

The Key to Healthy Liquidity is Often a Factor!



Thursday, June 10, 2010

The Cost of Factoring #1

In my last post I wrote about the differences in expected duration among the three basic types of factoring relationships. And I concluded with the point that those differences also caused the pricing of each to vary.

My next few posts will address the issue of pricing.

In any kind of financing relationship there are several elements that affect cost: size, duration, cost of origination and servicing, and risk of default, for example. And, of course, the provider of the financing has its own cost of capital to cover.

I started my career in the commercial mortgage business. One of the first things that I was taught was that it takes as much work to make a $1 million loan as it does to make a $10 million loan. Essentially the origination process is the same regardless of size. So, the smaller the transaction, the higher the relative cost of origination.

In the same way, the shorter the duration of the loan, the greater the impact of origination cost. Recapturing origination cost over one year will obviously require a relatively higher rate than recapturing that cost over ten years.

The same general issues hold true in the factoring business. Even though the duration of factoring relationships isn’t as long as those of mortgage loans, the principle is the same.

The longer duration of the traditional, full-line factoring relationship, allows pricing to be relatively lower because the factor’s costs are recaptured over a longer period.

In the case of a spot-factoring relationship, where it is possible that the relationship will consist of only a single transaction, origination costs will represent a larger component of transaction pricing.

The traditional, full-line factoring relationship will also typically involve a significantly higher volume of funds advanced than will the spot-factoring transaction. And the higher the volume, again, the lower the relative cost of establishing the relationship.

I’ve also noted previously that the companies that enter into full-line factoring relationships tend to be larger firms with longer track records and better credit than those that seek spot-factoring relationships.

Those characteristics obviously command lower pricing commensurate with lower risk.

So, the size, duration and credit risk in the typical full-line factoring relationship are significantly different from those in the spot-factoring relationship and those will all affect pricing.

More on this subject in our next post….

The Interface Financial Group has been helping businesses with their cash flow needs since 1971. Solving cash flow problems is what we do.

1 comment:

  1. This information is very useful for small business owners. It's good to know that there are sites like this that provide essential information needed for business companies to make a wise choice of factoring aids.

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