NEW YORK — As Wall Street, shareholders and lenders pressure companies to reduce inefficiencies, they often seek front-end solutions such as reducing head count, slashing advertising and cutting commissions.

This story first appeared in the September 20, 2004 issue of WWD. Subscribe Today.

But there’s one area in which a supplier can improve efficiencies while also protecting itself from credit losses, a solution that also improves cash flow, which is by sourcing out accounts receivable to a factoring firm.

According to Webster’s Third New International Dictionary, “factor” is defined as “a person that acts or transacts business for another.” It’s an old way of doing business and is the genesis of the modern real estate agent or broker. But today, it’s the business of handling a company’s receivables that carries the factor moniker.

Although there are many types of factoring arrangements, such as factoring with or without recourse, or advance factoring, the basic idea is simple, and works like this:

A supplier ships goods to a retailer. But through an arrangement with a factor, the supplier is paid by the factor for those goods shipped. The factor bills and collects the money owed on the goods from the retailer. For handling the transaction and doing the bookkeeping, and paying the suppler for the shipped goods, the factor charges a rate to the supplier.

Factoring arrangements are either done with the factor handling the transaction with recourse or on a nonrecourse basis. A deal without recourse, as the name implies, means that the factor takes on the credit risk.

There’s also advance factoring arrangements, which offer companies the ability to be paid as soon as the goods are shipped and invoiced. Barron’s Dictionary of Finance and Investment Terms describes this type of factoring as “discount factoring” where the “seller receives funds from the factor prior to the average maturity date.” This is based on the invoice amount, “less cash discounts” and allowances. In most cases, the factor is paid a rate based on “daily balances and typically 2 percent to 3 percent above the bank prime rate,” according to Barron’s.

There’s also maturity factoring, an arrangement where the factor handles all of the accounts receivable. Commission rates paid to the factors with these types of deals are between 1 and 2 percent.

In the apparel, home goods, fashion footwear and consumer electronics segments, there are a variety of product solutions offered by several large and small factors. Each of them positions themselves differently in the market.

CIT Commercial Services is the largest of the factors. The company, a unit of CIT Group, offers a broad suite of factoring and asset-based lending products for both small and large companies.

They offer traditional factoring as well as products such as CIT TotalSource, which the company describes as a “customized outsourcing program designed to manage the full life cycle” of a company’s accounts receivable.

The positioning of this type of product aims at taking on a company’s full accounts receivable, which cuts operating costs, bolsters cash flow and reduces write-offs.

Other factoring firms position themselves with similar products and solutions. The major points of differentiation include rates, level of service and size of client.

Rosenthal & Rosenthal and Milberg Factors, for example, tend to target mid-size companies with their services. They, along with DCD Capital, Sterling Factors and Hilldun, also focus on offering clients a high level of service. A higher level of service often means a higher rate charged.

Several of the major factors will also lend money with an asset-based agreement. It’s important to note that factors are experts at assessing the creditworthiness of retailers, which is valuable knowledge when competitive pressures swell and sales soften.

Moreover, factors are interested in developing longer-term relationships with clients, which is why they work closely with suppliers to help them grow their business.