Receivables
Factoring Calculator
What's
the best way to calculate whether it is worth it for my business?
This
page will show you how to calculate whether factoring receivables
makes sense for your business.
There
are two parts to this. The most important part is to get an estimate
of how much the extra cash flow could be worth to your business.
The second part is to estimate how much in additional costs you
might save by factoring receivables.
How
much is more cash flow worth to my business?
STEP
1: Calculate your typical gross margin
Just
subtract your direct costs (of materials and/or direct labor) from
your sales price, and then divide the result by your sales price.
For example, if you sell widgets for $100 each, and you pay your
suppliers $60 per widget sub-assembly, and then you spend $15 per
widget in direct labor to assemble them, your total direct costs
are $60 + $15 = $75. If you subtract $75 (total direct costs) from
$100 (your sales price), you get $25 (your gross margin), which
you then divide by $100 (your sales price) to get a percentage,
which is 25% in this example.
If
the number you get is less than 10%, please stop. Factoring receivables
probably doesn't make sense for you unless you feel you have the
option to raise your prices. (Keep in mind that you are not calculating
your "net" margin above, just your "gross" margin.
The fact is that if your "gross" margin is less than 10%,
you probably should not be factoring receivables.")
STEP
2: Guess how much you expect your business could grow without
any cash flow constraints.
This
is incredibly important, yet still a guess. Do the best you can.
Just ask yourself the magic question: "If I were completely
unrestricted by cash flow constraints, how much more would my business
grow?"
- Consider
the orders you remember having to turn down in the past because
you didn't have the necessary cash flow.
- Consider
the extra time you might devote to sales instead of cash flow
management.
- Consider
the types of larger customers you might pursue.
- Consider
the bids you couldn't make in the past because the orders were
too large for you to fund out of your bank account.
- Consider
the prospective customers who might be interested in other vendors
because you don't offer generous terms.
- Consider
the potential customers who might be inclined to choose you over
other vendors if you did offer generous terms.
Then,
pick a dollar number for your "potential sales increase"
on an annual basis.
STEP
3: Multiply the percentage of Step 1 with the dollar number
of Step 2
The
result is the incremental annual gross margin dollar benefit of
factoring receivables. If you can start factoring receivables and
pay less than this total dollar amount per year, it probably makes
sense for your business. Remember that you can find factoring companies
that will not require you to factor all invoices, so you can limit
your total dollar costs by only factoring a portion of your receivables.
How
much in costs could I save by factoring receivables?
Many
receivables factoring companies will provide all or a portion of
the following services in conjunction with receivables factoring:
- Credit-checking
your customers
- Confirming
invoices
- Collecting
invoices (and/or sending statements)
- Administration
(e.g. matching checks to invoices and depositing them)
You'll
still be required to create the invoices, of course. You'll also
be required to send the invoices somewhere (either to the factoring
company or directly to your customer.) And, if collecting on an
invoice is difficult, a factoring company will take your time by
involving you (frankly, if they don't, you might be at risk of losing
a customer.)
So,
knowing all the above, you can estimate the amount of time you'll
save (or your administrator will save) in performing the above tasks.
Figure out where you'd deploy that extra time, and figure out how
much that would be worth to your business. Note that you might not
save a penny in terms of actual hard dollar costs, but the time
deployed elsewhere could result in lower costs for your business…or
increased customer satisfaction or revenues. You are in the best
position to figure this out for your business.
One
other important thing: paying your vendors (or sub-contractors)
earlier
When
you start factoring receivables, you might choose to use the extra
cash you get to reduce costs with your vendors…or improve your
relationships with them.
For
example, you could:
- Start taking
vendor discounts, which are typically 2% if you pay within 10
days, but could be as much as 5%. You could also negotiate discounts
with vendors who haven't offered them to you directly. Most vendors
are willing to talk about this.
- Buy in larger
lots, thus taking advantage of volume discounts. That is, if you
normally only have the cash to buy small lots, but factoring receivables
would give you the cash to buy larger lots, you could save money
that way.
- Start paying
your vendors faster, to build goodwill. For some businesses, this
could result in receiving better quality products from your vendors,
faster delivery from your vendors, or some other intangible benefit.
This
one isn't easy to put into a formula. While it is easy to calculate
a 2%-3% discount you get for early payment from vendors (and then
you could subtract that 2%-3% from your costs of factoring receivables
to get the "net" cost of factoring receivables) the reality
is that for most businesses it isn't that simplistic. Generally,
you get other benefits from paying vendors early, beyond discounts.
Figure it out for your business as best you can.
Adding
it all up
If
you've been through the exercise above, you see that the answer
isn't a simple 1-2-3 math calculation. And, there is that psychological
component of having an extra cash flow cushion… that's difficult
to put into numbers. Do your best to estimate the benefits for your
business.
The
best rule of thumb we have? If your business is growing more than
20% per year (or, it could grow that fast if you had the
cash flow), and your gross margins are at least 15% or more, chances
are that you should consider factoring receivables.
To
better understand how much factoring receivables will cost, please
go back to the page on:
How
expensive is account receivable factoring?, and what other
terms should I pay close attention to?
To
learn more about the process of factoring receivables and selecting
a factoring company, here are the most helpful links:
How
does invoice factoring work? What is the process, and what
will my customers experience?
What
is the best way to select a factoring company? How do I
avoid the time consuming process of winnowing through all the factoring
companies out there, yet still get the best terms for my business?
How
do I know if I'll qualify for a factoring service? How do
I avoid spending a lot of time on this only to find out that nobody
will help me?
"Remember
that our site uses much of the industry terminology interchangeably.
Words such as Factoring
Companies, Invoice
Factoring, Factoring
Service all
reference the topic of this site, and you can click on any of those
phrases to go to the home page of our site."
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