If you are DTC focused, your Cash Conversion Cycle is probably some version of:
- Place PO with Supplier
- Pay deposits to Supplier
- Receive goods
- Pay final invoice to Supplier
- Sell goods online & get money
And you are probably financing that through cash, some form of short term loans or MCA, some longer term debt and maybe even equity (ouch). Or some combination thereof.
But now that you have entered wholesale (i.e. selling to retailers who then sell your goods), you have a new beast on your hands. All those yummy sales come at a big cost - a monster of a Cash Conversion Cycle.
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You haven’t seen anything like the payment terms from retailers. Get this new Cash Conversion Cycle wrong and you are upside down before you know it.
Enter Factoring. As I have written here and here, in choosing financing options it’s critical to match as closely as you can your ability to use your capital with the time to repay it. Look at the image above. Your money is fully out the door by Day 90. And you don’t get your cash until Day 210. Combining Factoring with other forms of short term debt helps you match to the entire CCC.
Here’s a brief overview of factoring.
- You present your invoice from Big Retailer or even Mom & Pop retailer to the Factor
- The Factor gives you an advance against the face value of that invoice. The percentage of the advance to the face value is the Advance Rate. Advance Rates will typically range from 70% to 90%.
- The Factor collects from the retailer.
- The Factor charges you a Fee of around 1% to 2% per month of the face value of the invoice for the time between when they gave you the advance and when they collected.
- The Factor then deducts their fee from the remaining balance and sends you the rest
For example, you have an invoice for $100K. The Factor advances you 80% or $80K leaving a balance of $20K. They charge 2% per month and it takes 3 months for the retailer to pay, so their fee is $6,000. And they send you $20,000 - $6,000 = $14,000.
There’s obviously a lot more nuance and variations to this simple version and you can check them out, play with pricing, compare terms and even understand your true cost with the Elephant Herd Short Term Lending Comparison Calculator below.
You can see why factoring can really help. Your Advance Rate is almost certainly higher than your COGS as a percentage of Net Sales to the Retailer (i.e. the face value of your invoice from the retailer multiplied by the Advance Rate is going to be higher than what you owe to your suppliers - if it’s not, we need to talk now).
So, you use some form of short term debt to pay the invoices to your suppliers and then use the Advance from the factor to pay back your short term lenders. The more of your principal you can extend out to the time you receive your Advance, the better. That’s why I stack ranked the short term lending options in the image as:
- Revolver (if you can get one)
- Other Short Term Debt (ideally one with with 90 day or longer terms - your ideal term depends on the terms you have with your suppliers)
- MCA - better than nothing, but your principal paydown will happen quickly
Let me know your thoughts and questions (DM’s open).
I am an Inflection CFO which means I help clients make the big jumps in financial performance through short term, high ROI engagements. If you need help, reach out.