Sunday, March 11, 2007

Factoring Receivables

Should I factor (sell) my receivables? I could use the cash, but the cost seems too high.

This question is hard to answer without more information, so let’s look at an example:

Let’s say it costs you $40 to make a product you typically sell for $100. If you could get $100 dollars in 60 days from your customer or $80 dollars in 10 days from selling the invoice, which would you prefer?

To compare the 2 options, let’s calculate the amount of Throughput that each option would generate in 60 days. Remember, Throughput* = Sales Price – Truly Variable Costs.

Option 1: We wait to collect the accounts receivable in 60 days. Therefore in 60 days we generate $100-$40 = $60 in Throughput.

Option 2: We sell the invoice and receive $80 in 10 days. Therefore we reduced our cash to cash cycle time and have generated $80-$40= $40 in 10 days. But we still have 50 days to go, so we invest our $40 in more raw materials and sell another product. For that product we also sell the invoice and generate another $40 in Throughput. We now have 40 days to go, so we repeat the process 4 more times. In 60 days we generate $240 in Throughput.

So the answer is “it depends”. If you have a use for the money that will generate additional Throughput, then you’re on your way to maximizing your cash flow and your profitability! If you have plenty of cash or access to low interest cash, then it doesn’t really make sense. Calculate the annual interest rate and you will see what I mean.

Another way to accomplish the same thing is to create a Mafia Offer where you offer deep discounts if your customers pay very quickly. However, if you decide later that you don’t want to offer this option anymore, then you have to explain that to your customers.

*Throughput is defined in Throughput Accounting as originally developed by Eliyahu M Goldratt, developer of Theory of Constraints.

1 comment:

Factoring and business credit builder said...

This information is very useful for small business owners. It's good to know that there are sites like this that provide essential information needed for small companies to make a wise choice of factoring aids.

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