I recently worked with two businesses that illustrate that working capital funding is an opportunity cost. Both businesses had the potential to increase sales by fifty percent (50%) over the next year. Both businesses had a gross margin of forty percent (40%). Both businesses were experiencing a lack of cash flow to facilitate growth and were seeking a working capital line of credit.

Company A had annual sales of $10,000,000.00, gross margin of $4,000,000.00, and average account receivable of $1,600,000.00. Their back log of work promised sales in the upcoming year of $15,000,000.00. In order to fulfill this opportunity for sales growth Company A needed cash flow funding to provide the working capital currently frozen in accounts receivable.

Company B had annual sales of $8,000,000.00, gross margin of $3,200,000.00, and average accounts receivable of $1,000,000.00. Company B had the opportunity to increase sales over the next twelve months to $12,000,000.00. Cash flow funding for working capital will be required for Company B as well.

Both companies initially sought a traditional bank line of credit secured by accounts receivable. Company A was approved for a bank line of credit in the amount of $1,500,000.00 at an interest rate of Prime 2.0%. Company B was approved for an $800,000.00 line of credit at Prime 2.0%. Both companies recognized that the working capital loan provided by traditional banking would not support their opportunity for growth.

A month by month projection of working capital needs indicated that Company A will increase accounts receivable from $1,600,000.00 to $2,500,000.00 within the first six months of the year. Company B will increase account receivable outstanding to $2,250,000.00 at the peak of their season. Company A will have a working capital shortfall of $1,000,000.00 with the bank line of credit. Company B will have a working capital shortfall of $1,450,000.00. With a $1,500,000.00 bank line of credit Company A can sustain its current sales volume, but not achieve sales growth. Company B has the same situation. Both companies explored alternatives for working capital funding.

By using a business financial factoring facility both companies will sell their accounts receivable to the factoring company at a discount. The factoring company will not set a credit limit ceiling on the amount of accounts receivable they will purchase from the company, thereby providing the companies with unlimited cash flow to fund working capital growth.

The discount fee for factoring of accounts will be three percent (3.0%) of the invoice amount. Company A will be able to achieve increased sales of fifty percent (50%), while decreasing their gross margin from forty percent (40%) to thirty-seven percent (37%). Company B will be able to achieve increased sales of fifty percent (50%), and decrease their gross margin to thirty-seven percent as well. Is this a good deal?

Company A will increase its gross dollars earned by $1,500,000.00 {current sales of $10,000,000.00 and gross margin of 40% = $4,000,000.00 gross dollars. Projected sales increase to $15,000,000.00 x 37% = $5,500,000.00 gross dollars. $5,500,000.00 - $4,000,000.00 = $1,500,000.00}.

Company B will increase its gross dollars earned by $1,240,000.00 by utilizing an accounts receivable factoring facility.

Company A recognized it's in the company's best interest to grow, and to have a working capital facility that can sustain its opportunity for increased sales, even though their gross margin will decrease. They accepted the factoring facility to provide the company with cash flow for sales growth, and increased their gross dollars by $1,500,000.00 in the next year - achieving their sale growth goal of $15,000,000.00 and gross margin dollars of $5,550,000.00.

Company B believed that the cost of factoring was too expensive compared to the cost of a traditional bank line of credit. Company B opted for the bank line of credit. At the peak of their season, Company B had utilized all cash available to them from the bank. Although they had the opportunity to increase sales by fifty percent (50%), they were limited to fifteen percent (15%) growth during the year as a result of the credit limit imposed by the bank. Their sales increased from $8,000,000.00 to $9,200,000.00 over the year. Gross dollars increased from $3,200,000.00 to $3,680,000.00. Company B did not reach the $12,000,000.00 sales volume that they had the opportunity to achieve, nor did they obtain the $4,440,000.00 gross margin associated with those sales.

The opportunity cost for a business encompasses more than simply the expense associated with the working capital facility. Company A was able to increase market share as a result of increased sales. Their position in their industry was strengthened. Company B saved money by accepting the bank line of credit over the commercial factoring facility. However, Company B lost market share to the competition because they did not have ample cash flow to service their sales growth opportunity. As a result, Company B's competition increased market share by providing services to the customers Company B could not serve.

For any business that has the opportunity for significant growth it is imperative that they have ample working capital to fund growth. Factoring companies can provide unlimited working capital to cash flow growth opportunities, giving the business a leg up on their competition. When sales plateau it may be wise for the business to consider a traditional bank working capital line of credit. But, in the interim, factoring of accounts receivable can provide the business with cash flow to achieve growth.