A Cost-Benefit Scenario for Invoice Factoring
There are many variables to consider when calculating the cost of factoring invoices. One of the benefits of factoring invoices is having access to your profits more quickly, thus increasing your production and profits. Here’s our scenario:
Mike’s Custom Golf Carts (Manufacturer)
It costs $7,000 to produce one golf cart in 15 days. A customer wants a golf cart and is willing to pay $10,000 for the cart, but needs net 30 terms. Mike will wait 45 days in order to recoup cost, thus slowing down the process of building a second cart.
It takes another $7,000 and 15 days to produce the second cart and another 30 days to get paid.
Now 90 days have passed and only two golf carts have been built and sold. Mike’s profit is now $6,000; still not enough to build two carts at once to get ahead. This process only allows Mike to produce nine golf carts per year, yielding $27,000 in profit.
What if you could get paid as soon as you deliver?
If Mike worked with a factoring company he could build a golf cart every 15 days, equaling 24 per year; thus leaving Mike a profit of $72,000 a year. The difference between $27,000 and $72,000($45,000!!!) is what it costs to NOT factor when your customers take net 30 terms to pay on invoices.
What about the actual cost of factoring?
Let’s continue with the example above, but now Mike is producing ten golf carts per month (thanks to factoring).
Golf World has agreed to buy ten carts every month with net 30 terms. Mike has terms with the factoring company of 1.5% for net 30 with an advance rate of 85%*.
Mike decides to factor Golf World’s invoices totaling $100,000 each month, allowing further growth. Upon Golf World’s invoice verification, the factoring company wires $85,000 into Mike’s account. Thirty days later, Golf World pays the factor $100,000. The factor deducts $1,500 (1.5%** for the factoring services) and pays Mike his remaining balance of $13,500.
Another cost saving activity to consider
If you were to factor your invoices, you would also be able to pay your vendors sooner and take advantage of the typical 1% to 2% discount vendor’s give for payment received within 10 days. In the end you will save more money, build credibility with your vendors, and have the capital to grow your business.
Get on the golf course!
Now that you’ve made the best financing decision for your company, it’s time to think spring and reward yourself with some serious recreation!
*advance rates may vary
** factor rates may vary