Using Financial Statements to Explain the Benefits of Factoring
As a Financial Broker, you know that sufficient business funding is a crucial aspect for any company. It provides the necessary working capital to start, grow and expand a business. Often times, you may encounter a business owner who is not familiar with invoice factoring and may be uncomfortable with the idea of factoring their accounts receivable. Helping these prospective clients better understand the concept and showing them the positive impacts to their financial statements is important to help them decide if invoice factoring is the right cash flow management strategy for their business.
In this article we will highlight the benefits of factoring for all three financial statements to give you ideas on how to explain the benefits to prospective clients.
Small business owners usually know the details of their income statement very well. They will appreciate the benefits of factoring and how it can boost their overall profitability.
- Additional Sales Volume and Increased Profit Margins: Invoice factoring can give clients the cash flow needed to accept orders that they might otherwise have to decline. Incremental sales boosts profits and cash flow in two ways: the additional profit from the sales volume, and assuming overhead costs don’t increase with the incremental sales volume, all the profit goes to the client’s bottom line. It’s a win-win opportunity that yields additional profits.
- Purchase of Quantities Eligible for Discounts: Invoice factoring can give clients the cash they need to buy inventory, materials, and supplies in quantities at more favorable prices. This reduces product cost and improves gross margins. For example, if your client distributes shoes to retailers for $40 per pair that cost $28 per pair and have a gross margin of $12 or 30%, and with cash from invoice factoring they are able to buy larger quantities for $24 per pair, their gross margin will increase to $16 or 40%. Purchasing larger quantities of inventory for existing orders can provide a boost to your client’s profitability.
- Early Payment Discounts: Invoice factoring can provide the cash flow for your client to take advantage of early payment discounts. With the extra cash flow, they can earn a substantial return from early payment discounts. For example, paying an invoice with terms of 2% 10 days, Net 30 days in 10 days means they give up the use of their cash for 20 days in return for a 2% discount. This will earn them a 36% (360 days/20 = 18 x 2%) annualized return. It will also help to build a good relationship with their suppliers by demonstrating that their business is reliable and financially sound.
- Elimination of Early Payment Discount Offerings: When your client uses invoice factoring, their cash flow is accelerated. There is no reason for them to continue offering customers a discount (e.g. 2% 10 days, Net 30 days) to pay invoices early. Eliminating early payment discounts can be a substantial savings and boost your client’s profit margins (usually by 1% or 2%).
- Reduction of Overhead and Bad Debt Expense: The credit and collection process can be handled by the factoring company saving the business time and resources typically spent on the management thereof. As the factoring company provides credit underwriting for the client’s customer base, the potential for bad debt losses is greatly reduced.
The benefits of boosting overall profitability with invoice factoring flow through to the balance sheet, and have the added benefit of helping to reduce liabilities and improve debt ratios.
The benefits of invoice factoring improve a client’s balance sheet in a number of areas, including:
- First and foremost there is an increase in the cash account. Factoring improves a business’s cash position as it provides immediate cash in exchange for accounts receivable. The increased cash can help a business meet its financial needs including such as paying expenses, covering payroll, or funding growth opportunities.
- The boost to overall profitability increases owner’s equity on the balance sheet and reduces the debt-to-equity ratio.
- The immediate cash flow from invoice factoring can be used to reduce accounts payable and other current liabilities faster, and help to build a solid relationship with suppliers.
- Having access to immediate cash flow can significantly improve operational liquidity and reduce the financial risk for the business.
- Factoring can eliminate or significantly reduce long-term liabilities or expensive lines of credit and improve debt ratios. Unlike traditional loans, invoice factoring does not add to a company’s debt load. Funds obtained through invoice factoring are not considered loans, but rather an advance on a business’s accounts receivable.
- Invoice factoring can eliminate the need for additional debt to bridge cash flow gaps, reducing overall financial obligations and improving the client’s balance sheet.
- The client will be able to offer their customers generous and flexible payment terms. The ability to do so may allow the client to generate new customers as result which may increase accounts receivable volumes.
The benefits from factoring on the client’s income statement and balance sheet ultimately are reflected the cash flow statement.
Cash Flow Statement
Factoring is a financial strategy that can help businesses improve their cash position and demonstrate that they are generating cash from operations. By selling their accounts receivable to a factoring company, businesses are converting an asset into additional cash to pay accounts payable and reduce debt. Leveraging invoice factoring effectively allows business owners to navigate financial hurdles and propel their growth.
Invoice factoring is directly tied to a client’s sales volume meaning that as they generate more sales and issue more invoices to customers, the potential level of funding available to accelerate cash flow also increases. This scalability ensures their funding and cash flow keeps pace with their business’s expansion. It makes this form of business funding an attractive option for businesses that need to manage their cash flow and short-term financial needs.
Using financial statements to explain the benefits of factoring provides a strong argument that business owners can relate to. Whether the prospective client is sophisticated financially or not, business owners know the importance of improving profitability and strengthening their financial statements.
Selecting the optimal business funding option is an important decision that requires careful consideration. Capstone’s invoice factoring programs can provide your clients with sufficient access to cash flow to drive growth and long-term success, while also helping to support healthy financial statements. Contact Capstone at (212) 755-3636 to find the best funding option for almost any business.