Factoring as a Strategy for Cash Flow Management

Factoring as a Strategy for Cash Flow Management

This article focuses on utilizing factoring as a strategy for cash flow management. Several ideas are proposed to maximize the advantages of using a factor within a transportation business.

Customer base segmentation

Fixed costs are predictable and can be integrated into financial planning ahead of time. However, variable costs vary and thus why every it is essential to know the break-even sales point and the contribution margin needed to cover the fixed costs.

Each customer must be providing a rate that allows the carrier to cover variable costs and have sufficient contribution margin left to cover fixed costs. If for example, a customer provides a sufficient rate for to cover variable costs, but the contribution margin is below the required amount to cover fixed costs, then not only will it be difficult for the carrier to meet their breakeven point but also an unexpected maintenance repair may put them in the red. However, carrier’s must be extremely cautious when evaluating customers and especially if they are thinking of ending a business relationship due to insufficient rates.

Customers that have long payment term duration can negatively affect cash flow. For example, customer A has a net-45 days payment term. Supplier has a net 30-days payment term.  The carrier begins business on December 1, 2010.  Invoices are sent at end of each month

Non-factoring example

Customer A Supplier B Balance on the 14th
February 15, 2011 – +200,000 February 1, 2011 -80,000 -$80,000
March 15, 2011 +200,000 March 1, 2011 -80,000 40,000
April 15, 2011 +200,000 April 1, 2011 -80,000 160,000

Factoring example

Customer A Supplier B Balance on the 14th
February 15, 2011 – +200,000 February 1, 2011 -$80,000 120,000
March 15, 2011 +200,000 March 1, 2011 -$80,000 240,000
April 15, 2011 +200,000 April 1, 2011 -80,000 360,000
342,000 (3% factoring fee)

As a result, you can see that the company that factors their invoices is ahead of their cashflow by +2x as much as the non-factoring example. The burden of cash-flow found in the non-factoring example gets transferred to the factor while the company itself has increased the amount of accessible capital it has. The non-factoring example must find a way to cover costs for a full 15 days of each month even if it results in a negative account balance.

Avoiding Misuse of Invoice Factoring

Often businesses become complacent when factoring their invoices and forget to follow sound cash flow management practices.

One such practice to follow is to only pay expenses on the date they are due or the day before. Paying expense bills before their due date is doing a disservice to your cash flow.

Develop a cash flow forecast that provides accurate estimates of the amount of money expected to flow in and out of the business on a weekly/monthly basis. Begin with a cash-flow statement and then work to create more intricate systems.

Factoring still requires in-house accounting to keep track of which invoices have been paid and which are outstanding to avoid interest charges by the factor.

Furthermore, establish an emergency fund for the business with savings to cover at least 90 days of expenses. This may take time to build but it will create reserves for the company and position it to withstand fluctuations in the business cycle. Also, by having a quicker rate of flowing receivables into the company than payables exit, you’ll be able to help the business ‘stay ahead of its time’.

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