This case study shows how invoice factoring can be used to solve the cash flow problems of a consulting company. We have changed some details (including their name) to protect client privacy. Also, the numbers have been simplified to make the case study easy to understand. However, the key facts and lessons remain.
1. Setting up the case
Business Consulting, Inc. (BCI) is a consulting company that helps large corporate clients overcome marketing challenges. The company provides its clients with strategies to help increase market awareness and sales. BCI is a small company with just a few employees.
They have built a great client roster and secured three large accounts. However, the company only has $15,000 left in the bank between start-up costs, hiring employees, and marketing expenses.
2. The challenge
Their three customers each pay $100,000 per month for services. Their customers pay their invoices in net-45 days. Consequently, BCI must wait 45 days after service delivery to get paid.
The company’s payroll is $165,000 per month. An additional $40,000 per month is spent on other general business expenses. The following table provides a simplified snapshot of BCI’s financial position:
| Clients | 3 |
| Cash (Bank) | $15,000 |
| A/R (Net 45) | $300,000 |
| Payroll | $165,000 |
| General Expenses | $40,000 |
| Cash Deficit | $(190,000) |
The company is doing relatively well, but its cash position is insufficient to pay all expenses. 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.
3. Solving the problem with factoring
BCI could solve its current cash flow problems using a line of credit or a business loan. There are four problems with this approach. Qualifying for bank financing:
- Is challenging
- Requires substantial assets
- Requires a long track record
- Takes a long time
A better alternative is to use factoring. It helps by financing slow-paying invoices from creditworthy commercial clients. A factoring line allows BCI to turn a portion of its slow-paying receivables into immediate cash. These funds can be used to pay company expenses and take on new customers.
Factoring transactions are not structured as loans. Instead, your company sells its invoices to a factoring company that pays for them quickly. Transactions are usually structured in two installments.
The first installment advances up to 85% of the total value of your accounts receivable. The second installment covers the remaining 15%, less the factoring company’s fees. This installment settles the transaction. The following table shows a summary snapshot of BCI’s financial position after deploying the factoring line.
| Clients | 3 |
| Cash (Bank) | $270,000 |
| Payroll | $165,000 |
| General Expenses | $40,000 |
| Cash Surplus | $65,000 |
| Factoring Company’s Reserve | $45,000 |
The first thing to notice is that the cash deficit turned into a cash surplus of $65,000. The $45,000 is held as a reserve by the factor and returned, less the finance fee, once the transaction settles. The company now has enough cash to pay its operating expenses.
Go deeper: To learn more, read “What is Invoice Factoring?“
4. After factoring: growth
The main benefit from this transaction is not immediately obvious from the post-factoring snapshot. Despite the high demand for its services, BCI could not take on new clients. They could not afford to offer commercial credit terms to their new clients. Growing 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. This growth increased their 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. This assumes BCI added two new clients and increased its accounts receivable to $500,000.
| Clients | 5 |
| Cash (Bank) | $440,000 |
| Payroll | $185,000 |
| General Expenses | $65,000 |
| Cash Surplus | $190,000 |
| Factoring Company’s Reserve | $75,000 |
Note: Click here for an image of the table.
BCI was able to achieve a financial turnaround relatively quickly using invoice financing. The company had several things going for it, which helped this happen.
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. This process would have taken less than a year.
BCI also worked with three large corporate clients. They were well-known, brand-name companies that 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. They no longer needed funding for their initial three clients. Basically, factoring allowed them to finance their growth.
6. Transitioning to a line of credit
The greatest challenge for BCI was that the cost of factoring was higher than that of other conventional financing products. This was not an issue when they had a cash flow emergency, and factoring was their only option.
Management strategically chose to use their receivables financing line as a steppingstone 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.
Marco Terry is the Managing Director of Commercial Capital LLC and has over two decades of experience in asset-based finance. He has worked with small and mid-sized companies across the United States, Canada, and Australia. Marco holds a Master of Science in Finance.