Too often potential clients will begin the factoring decision by looking at factoring discounts (percentages) on an annualized basis, like a car loan or a mortgage.

They take the 4% they are quoted, annualize it (multiply by 12) and respond with "you are going to charge me 48% interest!" At first that may seem like a factual, pertinent statement. However, we deal in short-term funding, our average invoice pays in 40 days.

When they respond that it is still "48% interest" we ask them to look at the 2% they offer for quick payment. That 2% discount is for payment in 10 days. In a year there are thirty-six 10-day periods - using the annualized percentage parallel, "that's 72% interest! Are they paying 72% for quick payment? No, and factors don't earn 48% for funding, either.

Why? Because factoring is short-term paper. To compare it to a long-term note is like comparing apples to oranges. In the end, the decision to factor always comes down to a business decision. If this money is going to cost 4%, can you take the money generated by factoring and earn more than 4%? after all, nobody factors just to have the money in their checking account.

Most businesess must weigh the costs of factoring against the costs of not doing it. Most often the decision is between factoring and putting up with cash flow problems.

If you are missing out on sales opportunities because of a lack of cash flow, be sure to consider that lost revenue when weighing the costs of factoring. Consider what increases in profits you can achieve with additional cash flow.

For example, in your current situation, without factoring, you have gross revenues of $100,000 a month. Your cost of goods is 65% resulting in gross profits of $35,000. Subtract overhead at 32% ($32,000) and you are left with a net profit of $3,000.

Now, consider what additional cash flow would enable you to do, such as take additional discounts for volume purchases, increase your sales and advertising effort, or add a second shift. By factoring the first $100,000 in receivables, we can project a doubling of revenue to $200,000 with a consistent 65% cost of goods (although this may actually come down depending on if you can receive discounts for paying in cash). This puts your gross profit at $70,000. Subtract overhead of $44,000 (which is more, but never double) and the cost of factoring - $6,000 - and you are looking at a net profit of $20,000.

So how expensive is factoring? In this instance, which is more than typical than not, the decision not to factor would have cost you $20,000 in missed opportunity for one month. So how expensive is factoring?

To accurately figure your profit margin with factoring, you must take into consideration the full spectrum of services offered. This is especially true if you are comparing factoring to borrowing then you are probably on sound ground. If you are looking to use the proceeds of factoring to pay overhead, to clean up bad debts, to pay past due cost-of-goods invoices, then you need to look carefully at what you are doing. Will this increase your chances of growing and expanding?