Invoice Factoring Case Study
This article assumes that you are familiar with factoring and know its benefits and advantages. But to summarize, accounts receivable factoring is a business financing tool that is used by companies that have financial problems because their customers are paying their invoices in 30 to 60 days. These problems manifest themselves all or some of these ways:
- Delays in your ability to pay current supplier bills
- Complete inability to meet current payment obligations
- Inability to take on new clients
Factoring solves these problems by financing your open invoices. This provides your company with immediate funding that can be used to pay suppliers, or to offer credit terms to new customers. The transaction concludes when your end customer pays their invoice in full.
Rates as low 1.5% for qualified clients. Advances as high as 85%
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Setting the stage - Small Business Inc.
For this business case we are going to use a fictional company called Small Business Inc. They provide consulting services and equipment to corporate clients. The company has been doing well recently and has been growing. Needless to say, the entrepreneur that started the company is very happy its performance. However, the company's president, John Sullivan, is concerned about the company's financial position.
Small Business Inc. has specialized in working with mid size and larger companies. As part of its contract with them, they have agreed to extend them 35 day term credit. These clients have good corporate credit, so John is confident that they will pay. However, they pay slowly. Unfortunately, the company has invested most of its working capital in growing and does not have any meaningful financial reserves to deal with payment delays. Because of that, John is hesitant to take on new clients because he can't afford the additional slow payments. John estimates that he has walked away from about $135,000 worth of new opportunities.
Let's take a quick look at Small Business Inc's current position. This report has been simplified and summarized to make it easy to understand.
Initial financial report - Small Business, Inc
|Lost Sales Opportunities||$135,000|
|Variable Costs (60%)||$207,000|
|Fixed Costs (rent, etc)||$45,000|
|Profit (Sales - Cost)||$93,000|
Given this situation, Small Business Inc. will not be able to grow and take on new clients until it builds a cash reserve in the bank. This reserve covers operating costs while waiting for payment. Building a reserve can take time, so plans to grow the company will go in the back burner for a while.
Instead, John decides to get an accounts receivable financing line to cover new sales only. This last point is important, he is only interested in using the factoring company to finance growth opportunities. After careful negotiations, he gets the following terms:
- Initial advance: 85%
- Factoring rate : 2% for 40 days
The financing facility follows the common structure in which the finance company provides the funding in two installments. The first installment (the advance) covers 85% of the gross value of the invoice and is provided as soon as the work is completed. The second installment (the rebate) covers the remaining 15%, less the factoring fee. Since Small Business Inc's customers pay on average in 35 days, the cost of financing will be about 2%. Now, let's see what happens when John implements the financing solution:
Current financial report - Small Business Inc. (using factoring)
|Factored (NEW) Sales||$135,000|
|Variables Costs (60%)||$288,000|
|Fixed Costs (rent, etc)||$45,000|
|Factoring Cost (2%)||$2,700|
|Profit (Sales - Cost)||143,300|
Additional profit: $ 50,300
In this case, the company increased its sales and made an additional $50,300 of profit ($143,300 - $93,000). An increase of 54.09% in profit growth for a financing cost of $2,700. The use of a receivables factoring solution placed Small Business Inc. on a more stable financial platform and allowed the company to capitalize on new sales opportunities.
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