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In today's economic environment, many practices are strapped for cash and are looking for ways to speed up collection of their accounts receivable. An expensive form of financing that some folks are considering is call factoring.

Factoring is basically when a practice borrows against it's current accounts receivable, typically insurance A/R, to obtain quick cash.

For example, say you have $75,000 in insurance accounts receivable - that is what you expect to collect after write offs and discounts - yet your practice seems to constantly be short of cash or "working capital". Some folks turn to a factoring company, and within a week or so, it buys your A/R and advances you 80 percent of its value, or $60,000. The factoring company then gives you the remaining $15,000 - minus some hefty fees - once it receives your A/R.

That instance influx of cash provides you with immediate working capital for today, but how will you fund your practice's operating capital a month or two from now? Factor your existing accounts receivable at that point? You can see why for most cases factoring just does not make sense. When you factor your A/R, you end up taking out a perpetual loan at an interest rate significantly higher that want the banks would charge for a normal loan.

A lot of the current financial institutions that push factoring are promoting it towards physician practices that are in financial distress. The key is, if your billing is where it should be, factoring should not even be needed in your physician practice as cash flow will be consistent and healthy.

In the medical industry factoring companies generally won't purchase A/R owed by patients. Some even walk away from receivables relating to workers' compensation. Their focus is typically on cash flow from traditional third-party payers. Checks from private payers generally go straight to the factoring company or a "lockbox" bank account in the doctor's name. The physician is still responsible for continuing to bill, posting payments and following up on denials.

Technically the law prohibits factoring companies from buying A/R from Medicare and Medicaid outright. Doctors can still include these amounts in A/R that they factor with out breaking the law, as long as government checks first go to a lock box account in the doctor's name.

For the most part factoring services offer the same basic terms. They usually advance up to 85% of the A/R on a daily, weekly or monthly basis. Larger advances can be made to doctors that can illustrate they have more reliable, faster-paying insurers.

The main difference between factoring services lies in the fees that they charge. The discount or factoring fee, which is equivalent to interest charged by a bank, ranges from 1 to 6 percent for every month your A/R remains uncollected. The more A/R your practice sells and the faster it can be collected, the lower the rate you will be charged.

In addition to the discount rate, factoring companies also charge a laundry list of other fees such as an application fee, a due diligence fee for evaluating your business and an origination fee for setting up your account. All of a sudden the initial 3 percent fee you were quoted by a factoring company doubles to 6 percent.

Does factoring ever make sense for a medical practice?

To the unsavvy business person, factoring may look like a life preserver to physicians that are drowning into deb but, in fact, it can increase debt, especially if you have a payer mix of slow paying insurers, which leads to interest rapidly accruing. A monthly discount rate of 3 percent translate into an annual rate of 36 percent, which is twice as much as what you would pay on an expensive credit card.

Factoring therefore should only be used as a short term solution when your practice is facing dire needs. The real solution is to identify the problem that is causing your practice to be in the position where it is considering and or needing factoring.

Often times this boils down to improving your practices billing and collections process. If this process is runnig smoothly and your A/R is getting collected like it should, factoring should not even come into play.

If you are in a situation where you are considering factoring because your cash flow is not where it needs to be, it may be time to seek outside help from a third party consulting firm that can help you improve your overall billing process and cash flow.