This case study shows how invoice factoring can be used to solve the cash flow problems of a consulting company. To protect client privacy, we have changed some details (including their name) in this business case. Also, the numbers have been simplified to make the case study easy to understand.
However, the key facts and lessons remain.
Setting up the case
Business Consulting, Inc. (BCI) is a fictional consulting company that helps large corporate clients overcome marketing challenges and provides them with strategies and solutions to help increase market awareness – and sales. Although BCI is a small company with just a few employees, they have secured three large accounts. However, between start-up costs, hiring employees, and marketing expenses, the company only has $15,000 left in the bank.
Their three customers each pay $100,000 per month for services. However, their customers pay 45 days after services have been delivered. The company’s payroll is $165,000 per month. An additional $40,000 dollars per month is spent on other general business expenses. The following table provides a simplified snapshot of BCI’s financial position:
Although the company is doing relatively well, it is low on cash and won’t be able to meet their general expense and payroll liabilities. It has a cash deficit of $190,000. BCI will have money coming in as soon as their invoices are paid. In the meantime, however, they are unable to meet their expenses.
Solving the problem with factoring
BCI could solve their current cash flow crunch using a line of credit or a business loan. However, there is a problem with this approach: banks don’t usually provide financing to small companies unless they have substantial collateral and a track record of profits. BCI has neither. Also, getting bank financing can often take a couple of months. This won’t help a company that need funds quickly.
Factoring invoices can solve the problem by financing slow-paying invoices from credit-worthy commercial clients. This solution allows BCI to turn a portion of their slow-paying receivables into immediate cash. Usually, the factor advances a portion of the outstanding invoices – 85% on average – to the client. The remaining 15% is held as a reserve until the invoices are paid in full. At that time, the transaction settles.
The following table shows a summary snapshot of BCI’s financial position after factoring has been deployed.
The first thing to notice is that the cash deficit turned into a cash surplus of $65,000. The $45,000 is held as reserve by the factor will be returned, less the finance fee, once the transaction settles. The company now has enough cash to pay its operating expenses.
The biggest benefit – growth
But the biggest benefit from this transaction is not immediately obvious from the post-factoring snapshot. BCI had been unable to take on new clients, even though demand for its services was high. They simply could not afford to offer commercial credit terms to their new clients, mainly because it would require an increase in employee headcount and associated general expenses. Unfortunately, growth was not an option, and even survival was questionable.
However, receivables factoring changed that. After implementing the plan, they were able to take on two new clients, which increased A/R by $200,000. BCI was able to easily pay for the increase in payroll and other expenses thanks to their financing line. The following table shows a summary snapshot of BCI’s growth financial position.
Why did receivables finance work so well for BCI?
BCI was able to achieve a financial turnaround relatively quickly using invoice financing. The company had a number of things going for it which helped this happen.
First, the company was well run and very profitable from the start. As is shown clearly in the second table, they had a sizable cash surplus after the first financing transaction. In fact, if they had chosen to stay at their current size and burn rate, they could have stopped using factoring soon after building an adequate reserve – a process that would have taken less than a year.
BCI also worked with three large corporate clients – well-known, brand-name companies who had great commercial credit. This simplified the process of financing their invoices because the collateral was excellent.
Above all, BCI’s management was smart. They were able to leverage their factoring financing line into a growth tool that allowed them to take on new clients. It wasn’t long before they were only financing invoices from new clients, as they no longer needed funding for their initial three clients. Basically, factoring allowed them to finance their growth.
Transitioning to a line of credit
The one challenge for BCI was that the cost of factoring was higher than the cost of other conventional financing products. This was not an issue when they had a cash flow emergency and factoring was their only option. However, management was smart and used their receivables financing line as a stepping stone to cheaper financing. Within two years, BCI was able to meet the underwriting requirements of a bank and secured a sizable line of credit. They used the line of credit to replace the invoice financing line, which reduced their cost of debt and increased their profitability.
This case study shows factoring at its best.