Page 198 - Finance for Non-Financial Managers

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Financing the Business
document amounts col-
lected, advanced, charged
company’s accounts receiv-
back under recourse Factoring The selling of a 179
able at a discount to a
agreements and so on. business (a factor) that assumes the
Besides their fees and credit risk of the accounts and
account-by-account scruti- receives cash as the debtors pay off
their accounts.Also known as
ny, the factor may build in
accounts receivable financing.
additional safeguards
against loss. It may, for
example, purchase invoices “with recourse,” meaning it has the
right to sell the invoices back to the borrower if it has not collect-
ed from the customer within a certain time, thus protecting the
factor from a loss of principal. There may also be other fees and
restrictions that effectively increase the cost of the loan even
more.
Don’t Let Interest Costs Eat
the Company’s Lunch
Factoring is a good example of borrowing that is costly
enough that it can adversely affect profitability if not used with care,
especially by companies with marginal profits. For example, a cash-
strapped company with a hot product may feel it makes sense to pay a
factor to get early access to cash so it can continue to expand sales.
But factoring charges add up fast.
Let’s suppose a company factors $1.2 million of sales under a plan
that charges 4% per invoice (a mid-range price) and customer balances
are outstanding for two months on average.That means the company
borrows, repays, and re-borrows $200,000 six times a year, paying
$8,000 in fees each time ($200,000 x 4%). In a year, the company pays
$48,000 in factoring fees ($8,000 x 6)—but has the use of only
$200,000 of the factor’s money at any one time. That’s an effective
interest rate of 24%! If the company nets 10% pretax profit from sales,
its pretax profit of $120,000 has been cut by 40% to gain access to
that cash.
Factoring may be a good decision, but only in special circumstances.
Managers should do their homework before choosing this option—
and any decision to use factoring for financing should come with a
plan to systematically remove the need in the future.