Factoring and Working Capital Financing in Canada – Do I know my' Cost of Credit'?

The cost of credit is the cost of not taking credit terms extended for business financing. When Canadian business owners extend, or receive business credit the credit terms are expressed as the amount of discount that is given for prompt payment, when the prompt payment discount expires, and when the invoice is due.

Let's look at an example. We might say that we are being offered 2% ten, net 30. What does that mean? It means that if we pay the invoice in 10 days we can subtract 2% of the invoice amount for our payment. We can assure you that your supplier, if it is your firm being offered the discount truly means ten days! Not take 2% and pay in 30 days as some try to do. (Those discounts are charged back)

Lets work thru and example. Supposed you are being offered 9000.00 of credit on 2% ten net 30 days. You can either pay 9000.00 x 98% = 8820$ in ten days, or of course, as we have noted, pay the full 9000.00 in 30 days. If your company is in a position to take the discount you can save a significant amount on your purchase price from that supplier.

If you wait the full 30 days you effectively borrow 8820 for 20 days, paying 9000- 8820 , or 180$ of interest .

So what is the 'credit cost 'in borrowing this money? The calculation is done as follows:

Credit cost = % discount / 100-%discount x 360days/ credit period – discount period.

If you work through the numbers in our example the credit cost = 36.7%.

As our example shows, the annual percentage cost of being offered a 2 % 10 day/ net 30 days scenario is almost 37%. Remember also that this discount is continually offered, so it was offered 18 times a year the effective annual credit cost is 43%!!

Selling on credit is an accepted an important part of business. From the customer perspective it's a source of financing, because you receive goods or services that you don't have to pay for until a specific future point in time, usually 30 days more often than not. As business grows between a supplier and customer the amount of financing being extended or taken grows.

So what is the final point of interest in our article? Its is as follows. More and more Canadian firms are looking at factoring and working capital financing facilities outside of bank financing. If our business could pay cash for goods and services we would take the discounts and arrange with our bank to allow us to pay for everything in Cash! Unfortunately our balance sheets and income statements don't allow us to generate those sorts of bank facilities.

Factoring is the immediate sale of our accounts receivable for cash. It also can cost anywhere from 1 – 3% per month in 'discount fees that are taken by the factor firm. Is that expensive. Yes. And maybe not! Because as we have seen if we can sell our receivables immediately for cash and then take supplier discounts we can offset a large portion , ( maybe all ) of the financing costs .

That allows us to be in the best of stead with our suppliers – We have cash to pay our bills and we receive immediate cash for our invoices. In a high growth scenario that's worth its weight in gold so to speak!

Factoring can serve the dual purposes of generating significant cash flow and receiving significant price or payment discounts from our preferred major suppliers.

That is a winning cash flow combination!

About The Author Stan Prokop is founder of 7 Park Avenue Financial - www.7parkavenuefinancial.com The company originates business financing for Canadian companies and is a specialist in working capital, cash flow, and asset based financing . In business 5 years the company has completed in excess of 45 Million dollars of financing for Canadian corporations of all size . For information on Canadian business financing and contact details please see : http://www.7parkavenuefinancial.com/Home_page.html