When accelerated and predictable collection of accounts receivable is the answer to cash flow challenges, the issues most often misunderstood are the cost of factoring, the perception of the account base and its impression of the financial strength of its vendor. How much does factoring cost? What will my customers think? Let’s discuss it!
Factoring, by definition, is the sale of your invoice, at a discount. The sale may be on recourse or on a nonrecourse basis. The discount may be one-time or a series of discounts as the invoice ages. That “Discount Fee” may be defined and should be included in your product or service pricing as you would any other cost.
Assume you are quoted a 3% “Discount Fee” for factoring your invoices. In your banker’s and probably in your CPA’s mind: 3% X 12 months = 36% per year! Well, we are not going to sell (factor) that invoice 12 times this year, we are only going to sell it once and we will also pay commissions on the sale only once! How about 10% commission X 12 months = 120% per year! How is that going to work?
Here is an example:
Sales Price of the Unit: 100%
Cost of Sales
Factor Fee: 3%
Gross Margin: 37%
Therefore, your opportunity is to leverage your book of receivables at a predictable cost. When all of the components of Cost of Sales are analyzed in pricing your product or service, factoring generally is the single lowest of all costs. In the example above and universally, the cost of OBTAINING the business is 3X the cost of leveraging the invoice.
If one were faced with the inability to capitalize a sale, would it make some sense to give up 3% of the gross margin rather than pass the sales opportunity to the competition?
As with commissions, factoring fees are usually a variable cost of sales and not a fixed cost. So, if you don’t have the sale, you don’t have the cost.
Now, you have decided you can surely afford to sell your invoices at a discount, the factoring company says it will notify your customers. You panic! Somewhere you heard that factoring means that you are less than credit worthy. The truth is bank financing may be beyond your company at this time because your sales have grown so fast, your banker is nervous. That should be good news! Often it is not at the bank; it is at Far West Capital.
We find that your largest 5A customers are indifferent to where your invoice is addressed. Their payables department simply changes payment instructions and everyone is happy. Your smaller customers will pay a little more attention to the destination of the payment and may ask questions, but guess what else they will do? They will pay your invoice first and you will actually see an improved turn on that segment of your account base.
Need to talk more about how much factoring costs and how it will affect your customers? Give us a call and let’s chat!