business

Cash advance: Should you sell your accounts?

Accounts receivable financing can get you money in a hurry. But it comes with a price.

By — Posted Jan. 30, 2006

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Payroll is due. Vendors are sending you bills. Your office rent is late. You need to come up with a substantial amount of cash, and soon.

But you are waiting, and waiting, and waiting, for third-party payers to furnish you with the income that enables you to meet these obligations.

It's a problem endemic to medical practices, and one that has forced an ever-increasing number of them to turn to a controversial strategy: accounts receivable financing.

There are plenty of banks and other lenders all over the country -- and all over the Internet -- who are willing to take your accounts receivable in exchange for a quick cash payment up front that might enable you to pay off your debts, buy equipment or otherwise invest in your practice. Some even might tell you that it will provide asset protection in a liability case.

But like most other things that sound too good to be true, there are catches.

For one thing, practices that take out loans or lines of credit against their accounts receivable might be paying a higher interest rate than in other types of lending. And those that sell their receivables to a third party in a transaction known as "factoring" should expect only about 80 cents on the dollar for the value of those accounts. Also, some experts say getting payments now against future income can create a vicious cycle that is difficult to stop.

"If you give up your accounts receivable, you get to buy your piece of equipment and expand. But how are you making your payroll next week?" asked David Scroggins, a management consultant at Clayton L. Scroggins Associates in Cincinnati.

As described by Rick Buchsbaum, a consultant with Brentwood, Tenn.-based Progressive Healthcare, this type of financing can create situations in which the practice doesn't have enough cash coming in each month so it is "robbing Peter to pay Paul."

Both factoring and using accounts receivable as collateral are often done over an extended period of time. "When you do either one of these, you're really contemplating that you need this funding going into the future for at least a year," said Pat True, senior vice president of bank services for Insight Healthcare Financial of Madison, Tenn.

But True said these are not necessarily permanent situations. Essentially, if you're hoping that accounts receivable financing can provide you with some relief, you're betting that your practice can grow enough in time to cover the payment so you don't have to go back to that same well.

"If [practices] hold enough and retain earnings and become more of a cash business, they'll eventually graduate from that line of credit or factoring relationship. They'll become a self-funded business," he said.

And indeed, that can happen. But many experts say you'd better have your finances mapped out enough to know that you can handle the high cost of a quick cash infusion.

The old receivables factor

Factoring and collateralizing accounts receivable are two different strategies with their own sets of pros and cons. Both may be alluring to practices in need of cash, but some experts say factoring might be the only financing avenue available to those that might not qualify for a line of credit or bank loan, such as a startup practice.

Under a typical factoring scenario, the bank or factoring company will offer immediate cash to buy receivables that the practice might not otherwise collect for 60 to 90 days. But the offer comes at a premium: The receivables are bought at a discounted rate that varies depending on the expected performance of the accounts.

"The factoring company is going to try to evaluate who the payers are, what their historical performance is, and how many days on average it takes them to remit payment," True said.

The discounts range widely. John Torr, director of business development for Senex Services Corp., an Indianapolis-based purchaser of bad debt health care receivables, said the "freshest" receivables, or those with the highest probability of collection, might sell for 92% of their value. On the other end of the spectrum, old receivables could go for as little as 5% of their value or less. Buchsbaum said a typical sale goes for about 80% of the value.

The discounts can add up to take a big bite out of the income due to the practice. So can taxes, because you have to pay them based on purchase price. Buchsbaum, for one, believes that cost is too high to justify the action unless it is the only option available for generating cash. "To me, factoring would be a last resort because of its cost," he said.

True said there might be some minor additional costs for transferring funds, handling paperwork or for other reasons. But the bulk of the expense of factoring comes from the "discount" price of the accounts receivable.

Some receivables might be excluded from the deal. Typically, factoring companies won't buy patient receivables because they can be so hard to collect, and therefore would be discounted too much to be worthwhile, Buchsbaum said.

Receivables due from government payers may need special handling because of rules governing Medicaid and Medicare, True said. In such cases, the physician may need to create a lockbox in his or her name to take in the receivables before they are passed on to the factoring company.

Factoring comes in two flavors: full-recourse and nonrecourse. Under the full-recourse option, the most common type of factoring in medical practices, the factoring company can return to the physician any receivables that weren't collected after a certain amount of time and might be entitled to restitution for them. Under these scenarios, the physician typically maintains responsibility and control over collections.

If the value of the receivables changed because of denied claims by third-party payers, the physician practice might be responsible for making up the difference under a full-recourse factoring relationship, True said.

With nonrecourse factoring, the factoring company typically takes on all the risk of collections. This is a riskier proposition, so it tends to be more expensive. Also, in nonrecourse situations, the factoring company might engage in its own collections. True said that could raise concerns for physicians who don't want unknown parties handling collections with their patients.

Factoring is sometimes marketed in conjunction with other financial vehicles, such as life insurance. The basic idea is that the money generated through factoring can be put to use as an investment. But there is plenty of skepticism about such plans, and critics point out that these strategies don't offset the basic risks associated with factoring.

In other instances, accounts receivable financing has been touted as an asset protection measure for physicians who are concerned about liability judgments dipping into their practice coffers. The idea is that you're taking your most-exposed asset -- the money you have yet to collect -- and stripping it of its value to creditors. In factoring, this is done by selling it off. With a loan, this occurs because a bank already has a lien against your accounts receivable. No one ever has successfully "penetrated" receivables in such scenarios, "to the best of our knowledge," said Richard Campanaro, president and chair of Atlast Financial Services LLC, a Jacksonville, Fla.-based company that markets an accounts receivable wealth accumulation program for physicians.

But Buchsbaum said accounts receivable financing isn't something that should be used as a defense strategy. One problem: You have to constantly finance your receivables in order to keep their total down. "The best form of protection for medical liability is good insurance," he said.

Line of credit

Although there are many scenarios in which accounts receivable might be used as some form of collateral for a bank loan, one of the more common situations is when a physician practice collateralizes the receivables for what essentially amounts to a line of credit.

"Usually the line of credit is used for cash flow. I'm starting up, and it's going to be 90 days before I collect anything, but I have to pay my staff, pay my bills and pay my mortgage, so I need this line of credit to get through," said Kevin Stone, senior consultant and principal at Helms & Co., in Concord, N.H.

The credit line or loan may require other collateral, such as equipment, and might even require personal guarantees from the physicians.

Stone said banks often see accounts receivable as the practice asset with the best economic value, which might make them more willing to lend against it. But more and more lenders might require physicians to provide a business plan proving the viability of their practice before shelling out any money, he said.

Scroggins said physicians themselves might be well-served by examining their business plans before borrowing against their receivables in this way. "You ask yourself as a doctor: Is this a good business decision? Will I be able to make the loan payments because the x-ray [machine] I'm putting in is going to be generating enough cash flow to make those payments? You have to ask, 'The access to cash, will that make me more money?' "

As with factoring, lenders might ask the physician to create a lockbox through which the accounts receivable can be funneled, enabling them take control of the stream of payment, True said. There could be some fees associated with this function.

True said the rate of the line of credit is typically a little more than prime, which is about 7%. But Buchsbaum said that, depending on the type of borrowing, the rates could range up to 16%.

Stone said the rate may vary depending on the size of the bank. He said smaller banks might be more willing to take a chance on a prospective borrower. Either way, he recommends shopping around before committing to a lender.

In choosing a factoring company, Torr said physicians might want to consider using a larger firm. "They may be able to collect a little more because of their expertise or volume," he said.

But a larger company does not always produce a better outcome. National Century Financial Enterprises of Dublin, Ohio, was one of the largest receivables purchasing firms in the medical world when it collapsed in 2002 amid a fraud scandal. The Securities and Exchange Commission, which in December 2005 filed a civil lawsuit against former top NCFE officials, said the collapse caused investors to lose more than $2.6 billion and forced nearly 275 health care practices and others into bankruptcy. The former executives have not yet responded to the charges.

"It really gave the industry a bad name," Torr said.

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ADDITIONAL INFORMATION

Pros and cons

A report prepared for the American College of Emergency Physicians in May 2004 considered aspects of factoring:

Advantages

  • Rapid availability of cash.
  • Mitigation of bad debt risk of individual payers.
  • Avoidance of debt.
  • Easing of cash-flow disruptions associated with third-party billing.

Disadvantages

  • More expensive than traditional loans.
  • Funds available are limited by the size of the accounts-receivable pool.
  • Potential public relations problems if the factoring company handles the billing and does it poorly.
  • May diminish the ability of the physician group to secure other financing.
  • A bankruptcy by the factoring company could cause immediate disruption of the physician group's cash flow.

Source: American College of Emergency Physicians

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5 steps to factoring

Factoring is selling your accounts receivable for a discount to a bank or financing company. Here's how it works:

  • The physician practice offers a factoring company its outstanding collections.
  • The factoring company assesses the value of the receivables, excluding self-pay patients.
  • The company determines the discount rate at which it will purchase the pool, based largely on the likely collection rate.
  • The factoring company pays the physician practice for the discounted receivables.
  • When collections come in, they are directed to the factoring company.

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