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AN EXAMPLE
OF HOW FACTORING CAN BENEFIT A SMALL BUSINESS
A Small Business Without a Factor
ABC Manufacturing Corporation
currently produces $500,000 a year in sales. The business makes a
30% margin on sales. In other words, if sales are $500,000 he can
expect to make a gross profit of $150,000 a year. However, sales
are limited by the amount of money the business has available to
buy materials and pay employees.
ABC
Manufacturing Corporation
Condensed Income Statement (Without
Factoring)
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Sales
Materials
Payroll
Gross Profit (30%) |
$500,000
$175,000
35% of Sales
$175,000 35% of Sales
$150,000 |
In this example, due to cash flow
restrictions, ABC Manufacturing Corporation is constrained to
sales of $500,000 a year. As a result, until ABC can accumulate
more working capital, it can only make $150,000 a year. With a
factor, ABC’s business would not have a cash flow restriction.
A Small Business With a Factor
In this example, sales at ABC
Manufacturing Corporation are no longer limited because of cash
flow problems. ABC can market its business without the worry of
paying vendors or employees. ABC can now collect cash as soon as
it produces, delivers and bills for its product. As a result, it
can increase sales, as well as, take prompt payment discounts from
vendors (for materials). Now ABC Manufacturing Corporation can
increase sales to $1,000,000 a year. ABC also has the cash to
take prompt payment discounts from their vendors (as much as 6%).
ABC sells its invoices at an average factoring discount of 5%.
(This average fee is probably high, but will be good for our
example.) Now that ABC is factoring, let’s take a look at the
income statement for ABC Manufacturing Corporation.
ABC
Manufacturing Corporation
Condensed
Income Statement (With Factoring)
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Sales
Materials
Less Prompt Pay Disc.
Payroll
Factoring Discounts
Gross Profit (27%) |
$1,000,000
$350,000 35% of Sales
($14,000) 4% of Materials
$350,000 35% of Sales
$50,000 5% of Sales
$264,000 |
In this
second example, factoring has eliminated ABC’s cash flow
restrictions. As result, ABC is able to double sales to
$1,000,000 a year and take a 4% prompt payment discount from his
vendors. Profits change from $150,000 to $264,000 a year. This
means that ABC Manufacturing Corporation makes an addition
$114,000 a year (a 76% increase). Over three years, ABC would
make an additional $342,000. That’s real money!
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