Probably the most effective means to understand the power of factoring, or accounts receivable financing if you prefer, is through a real life example. To learn how other entrepreneurs are growing their businesses by using this powerful financing tool.
The following is just such an account. Learn how Bob, (name has been changed), used factoring to take on a very lucrative account. See how not only his business grew, but how his bank account exploded! Note too how many more people now have jobs.
Bob’s Security Guard Service
Bob’s security guard company provides 24 hour security services to gated communities. He gradually built his company over a period of five years and gained an excellent reputation for service. But like so many other business owners that provide such a service, Bob had to wait a long time to be paid. Meanwhile, he was paying his employees on a weekly basis.
Property management companies that hire such services are notoriously known to be very slow payers. This slow payment cycle greatly hampered Bob’s ability to grow his company due to the payroll constraints that it caused. Bob had tried on two separate occasions to secure financing from his local bank, but to no avail. His slightly tarnished credit record and lack of hard assets to use as collateral kept him from getting the financing he needed.
A very lucrative opportunity presents itself
One day, Bob is offered the contract to provide security guards for 37 gated communities in his area. The size of his business would triple overnight. But of course, their is always at least one caveat to every good offer. The property management company making the offer takes 75 days to pay on invoices.
So Bob does the math. The 37 gated communities would require 40 guards to cover all entrances. Each community requires around the clock security. So 40 guard positions times 3 shifts means that he would need to hire 120 more guards to cover the contract. Each guard makes a salary of $480 per week. Bob’s weekly payroll requirement would be $57,600.
Since the property management company takes 75 days on the average to pay, Bob knew he would have to bankroll 11 weeks of payroll before he would receive his first payment. So, 11 weeks times $57,600 would mean that Bob would spend $633,000 in payroll alone before he saw his first dime. In his circumstances, Bob realized that there was no way he could “afford” to take on this lucrative contract.
Or was there?
Factoring to the rescue
Bob remembered that he had recently read a brochure about the benefits of factoring and it’s powerful ability to finance payroll. So he called the broker that had sent him the brochure and explained the offer to him and his financial dilemma.
The broker explained that factoring would provide him with the financial ability to say “yes” to this new offer. And a factoring arrangement was set up so Bob could accept this lucrative, but payroll demanding, contract. But how did Bob’s factoring arrangement work?
How Bob’s factoring arrangement was structured
One of the first considerations that the Factor would take note of is that the property management company would take 75 days, or 2 1/2 months to pay on Bob’s invoices. That would be a bad note. A second consideration is the dollar amount of each invoice, over $57,000. That’s a large amount, and is a good note. A third consideration, which is also a good note, is that the Factor collected that amount from only one source, the property management company. A fourth consideration would be the creditworthiness of the property management company. Could they be trusted to pay on their invoices?
Apparently they could. Bob was told that a factoring arrangement could be set up to cover saying “yes” to this contract. The Factor would cover Bob’s invoices at a fee of 0.9% per every ten days that it took the property management company to pay. Or 6.3% for a 75 day cycle, (the first 10 days would be at no charge).
On a weekly basis, Bob would submit an invoice to the property management company and fax a copy to the Factor. The Factor would advance Bob 80% of the invoice amount and wait to be paid by the property management company. Once the Factor was paid by the property management company, then the Factor sent Bob the rest of his money minus their financing fee.
So Bob did the math again. With a 20% profit margin, a 6.3% factoring fee was no problem. He was going to profit a gross of over $7,800 a week, or over $400,000 a year, from just this one contract! So what was once a hopeless situation is now a no-brainer.
Take-aways from Bob’s story
- Time sensitive opportunities present themselves to business owners. No time to waste chasing funding.
- Personal circumstances can inhibit one’s ability to get financing through the local bank. With factoring, a slightly tarnished credit history and lack of hard assets for collateral are not a problem.
- Alternative options are available.
- A lack of cash flow can keep a business owner from accepting lucrative opportunities that will grow their business and bank some serious cash.
- A 6.3% factoring fee may seem like a lot. But remember, Bob increased his personal income by over $7,800 a week; over $400,000 a year. Plus, Bob’s company is supporting 120 more jobs.
Do this math: What is 6.3% of $0.00. That’s right, nothin! That is how much Bob would have increased his personal weekly and yearly income without factoring. And how many jobs will that support? The bank wasn’t going to give him the money. So it doesn’t matter how much interest a bank would have charged for a line of credit. If he doesn’t qualify for one, their interest rate would be irrelevant.
Tip: Bob did not have to always submit invoices to his factor every week. Once he was financially able to, he could hold on to his invoices for another or several weeks. This way, the amount of days of financing would be cut shorter; and therefore, the fee would be less.
6. A less obvious take-away: Now that Bob had a factoring arrangement in place, he could factor the invoices of all of his creditworthy clients. Both his previous clients and his future clients.
From this one client, he would be factoring around $275,000 a month. Suppose later another similar contract was offered to Bob. As long as his Factor thought the payer was creditworthy, that account could be added for factoring. Suppose Bob grows his company to a million dollars of invoicing a month – covered. Two million dollars a month? Covered. He may have to change to another Factor that can handle that monthly amount, but the ability is there.
Factoring is powerful
So hopefully you can see what a powerful financing tool factoring is, and how practical it is. How it helps businesses to grow and thrive. How it creates jobs and allows business owners take advantage of opportunities. I am sure “Bob” is glad he knew about factoring.