You have already talked to your banker about setting up a working capital line of credit, but after finding out that you are in the contracting industry, your banker gives you a look as if he is a deer caught in headlights.

Bankers have been burned too many times by contractors and are very cautious about lending money to them. When they do, a compensating balance may be required to be kept with the bank. A compensating balance is simply the amount that a banker uses to offset the loan balance you are authorized to receive.

Furthermore, a fee is often charged against any amount that your company does not borrow against (up to the agreed upon limit), whether you use the money or not. This is because the banker has to tie up the money for your use and cannot lend it out to other businesses.

When compensating balances, fees, and interest are taken into consideration, bank loans can become much more costly than the quoted interest rate - not to mention the fact that a line of credit is debt, and you are responsible for the repayment of that debt. Most often you are personally liable for it.

Another Option

One alternative to going into debt to raise cash is to utilize a financial instrument called "factoring." Factoring is simply the outright sale of your receivables to an investor or, more commonly, a commercial finance company.

When your company factors its accounts receivables, it actually sells the accounts receivables for cash. A business owner that factors its receivables can generally have the cash in hand within 48 or 72 hours of completing the application paperwork. The pluses of factoring go beyond fast cash. No personal guaranty is needed when it's set up as non-recourse funding and outsourced collection services.

Yes, a factoring company actually handles the collection of the receivables, eliminating the need for the business owner or office staff to go through the time and effort in-house. Reputable factoring companies are very professional and courteous to your customers.

The downside to factoring receivables is that the factor charges a discount of between 2 percent and 10 percent for its services, depending on the risk and the collection time frame.

However, when compared against not making payroll, not taking vendor discounts, and certain lending fees, factoring can begin to look more appealing. If your competitive landscape permits, it may even be easier to offer your customers longer terms (60 to 90 days) and build the factoring fees into your price.

Roberts is owner of Roberts Commercial Lending Co. He can be reached at 810-602-7881 or CommercialFnnc@aol.com.

Publication date: 07/26/2004