How much is it? No we aren’t in line at a department store, we’re sitting with our clients who are always asking what the true cost of factoring receivables is and if a receivables financing facility is their real solution for working capital problems. They ask other questions also, such as how the facility works and what is the best type of facility for the Canadian business marketplace, so we we’ll cover those off also .
We don’t think there is more of a mis understood business financing in Canada, notwithstanding the fact that receivables financing is growing in popularity traction everyday. The biggest stigma around the topic is really the true cost, and we use the word true cost because many Canadian business owners and financials managers simply don’t understand the components of that true cost, and moreso, how these costs can be significantly offset and reduced.
We’ll point out that coming up the rear fast and furious behind true cost are the issues of how the facility works and what type of facility is the best one in Canada – as there are several types.
To properly address our issue lets quickly define our subject – factoring, ( also called receivable discounting and invoice financing ) is simply the sale of your receivables to a third party firm, that firm providing you with immediate ( and we mean same day!) cash to finance your business
One of the misconceptions clients have around pricing is related to the fact that you receive (depending on who you are dealing with) 80-90% of your invoice amount in a receivables financing scenario. This must be taken into account when you are looking at total factoring cost.
One thing that constantly disturbs us is that the terminology mumbo jumbo that many factor firms use when they are offering you pricing on your facility. That’s why it makes total sense to talk to a trusted, credible, and experienced Canadian business financing advisor that will work with you through the (industry created) maze of factoring, factoring cost, and day to day paper flow.
You can quickly and easily focus in on the true cost of factoring by simply keeping in mind three things that you need to know – they are:
1. The percentage that you are advanced on your invoice (refer to our previous comments)
2. The discount rate charged on the advance
3. The length of time that you typically collect your receivables in
Most business owners are not readily facility with their DSO, their ‘ day’s sales outstanding ‘. You have to be, because it’s an ongoing measure of the time it takes to collect your receivables in days. It’s calculated simply by taking your receivalble on an annual basis, multiplying them by 365 (days) and then dividing that number by your sales for that time period.
Therefore, if you know your collection period, and get an honest, clear answer on our three points you can easily determine the cost of factoring.
Let’s give you a clear example: Your factor firm advances you 80% of your invoice. Their discount rate is 3%. So if you are in the lenders shoes your annual return on the client (that’s you!) is simply: Discount rate % times 365 days Divided by number of days invoice is outstanding.
In Canada that rate is typically going to work out to be in the 1.5-3% per month range depending on the lenders perception of the size and quality of your accounts receivable portfolio.
Is that expensive financing? You tell us, because if you take into account the receivables financing facility provides you with unlimited cash flow to generate sales and profits, and that you can use the cash to offset financing costs, well… we dont think so .Costs can be offset by using the funds to take supplier payment discounts, and purchase in larger volumes and better prices re your inventory needs, etc.
Speak to that trusted, credible business financing advisor we spoke of, he or she will guide you through the receivable discounting maze and set you on course with the right facility at a price that makes sense to you.