2 weeks ago, I posted a blog about “Financing Growth for Small Businesses”. I’d like to expand on the topic and discuss more about what that entails.
When is factoring a viable cost effective cost of sales? One example is a business service in which the company has an opportunity sign a new contract that requires adding employees. If factoring is the only available source of working capital, the alternative is foregoing the contract. The company can receive factored funds upon issuing the invoice and use the funds for the payroll period matching the invoice. Executing factoring results in a ‘cost of sales’ likely amounting to 2% to 3% of revenue if customers pay within 45 days. If the expected gross profit margin after incurring this ‘cost of sales’ is still reasonable, then the business can commit to the contract and realize the remaining profit margin.
For businesses with short production cycles, or purchasing and distributing products, the same perspective applies. Cash from factoring is used to pay for labor, materials, or purchased inventory in conjunction with completing delivery and issuing an invoice to the customer. Again, used properly as a short term source of working capital the cost of factoring is essentially a cost of sales.
Some businesses need working capital funds upon signing a purchase order but prior to completing delivery and issuing an invoice. If a business must pay payroll, materials or purchased inventory prior to delivery, purchase order financing may be a viable source of funds similar to factoring. Purchase order financing is often twice as costly as factoring because there is higher risk in that the customer has not yet acknowledged accepting delivery of the product. Again, if the expected gross profit margin after incurring this ‘cost of sales’ is still reasonable, then the business can commit to the contract and realize the remaining profit margin.