It's About Time!

The most a business can afford to pay for financing, on a sustainable basis, (whether from a factoring company or any other source)is the difference between gross revenues and all non-financing related costs, including a return to the owners.

A business can run a deficit for a while. Owners might be able to forgo returns for a while. And non-cash costs can be ignored for a while.

But in the long run, if the business model does not generate enough "room" to pay for outside financing; taking on outside financing is going to cause problems.

There are three principal issues to consider in deciding how much outside financing a business can reasonably support:

a) the amount of the financing,

b) the return required by the financing source, and

c) the length of time the funds will be needed.

In the factoring business it's not often the case that the AMOUNT of financing provided gets a business owner into trouble. That's because the amount of money advanced by a factor will be a percentage of the accounts receivable.

If the receivables bear a reasonable relationship to sales and assets and the factor's advance percentage is typical, the size of the financing should not be large enough, in itself, to get anyone in trouble.

The return required by a factoring company, in the same way, should not be the source of a problem. The reason is that it's a known quantity.

Whatever the rate is: however high or low it might be; in the spot-factoring business especially, it's no secret. Both parties know what the periodic cost of funds will be.

No. In my experience, the source of almost all problems of affordability is TIME.

I'm not talking about other things that might go wrong in a transaction or a relationship. I'm talking about an affordability problem that comes about either as a surprise or through self-delusion.

Those problems arise when payments are late. Because when payments are late, costs rise.

If the payments are late enough the entire margin available for financing costs can be exceeded, sometimes pretty quickly.

If a financing facility has been structured and appears comfortable to all based on receipt of payments in 30 days, and all of a sudden payments are taking 90 days, the cost of financing can overwhelm a business owner.

And when business owners get overwhelmed problems of all sorts can arise.

I've had the experience of "word getting around" that I target a 45-day payment cycle only to find that every prospective client I talk to expects to paid in 45 days! When we actually look at an aging report it often becomes apparent that the 45-day cycle is a fantasy.

Here's the message of the day: It's all about time.

The quickest way to get into trouble is not a function of the rate you're paying; it's a function of kidding yourself about how long you'll have to pay the rate.

An annual rate of 100% might seem quite reasonable if the transaction is only open for a few days.

But a rate of 20% can be ruinous if you've deluded yourself about how long it has to be paid.

It's about time! Not rate.

What Matters Most to Business Owners

I’m going to interrupt my series of posts on the subject of opportunity cost to share some information about the motivations of private business owners that I found very interesting.

The data comes from the Pepperdine University Private Capital Markets Project, which conducts extensive regular interviews among both the providers of capital to privately-owned business and the businesses that seek private capital (as opposed, that is, to raising capital in the public bond and stock markets).

In the Winter 2010 edition of the Pepperdine report is a fascinating section entitled “What is most important to you as a business owner?”.

The three goals to which the participants were asked to respond were:

1. Maintaining current lifestyle.

2. Dramatically increasing lifestyle.

3. Financial independence (defined as increasing the value of their business by at least 3 times)

The possible answers were:

a. Most Important

b. Next most important.

c. Least important.

Here’s what I found most interesting.

The least important goal of these business owners, by far, was “Dramatically Increasing Lifestyle” with only 9.9% choosing that as their most important objective.

By far the MOST important goal, chosen by 67.3%, was “Financial Independence”.

Note the definition of “financial independence” is a function of building value in their businesses; specifically, increasing value by at least 3 times.

“Maintaining current lifestyle” was actually seen as more important than dramatically increasing lifestyle.

So these owners of private business are pretty much content with their CURRENT income. What’s really important to them is building value in their business to provide for their FUTURE independence.

This idea of weighing current benefits against future benefits is a fundamental issue in applying opportunity cost analysis, which is why I bring this topic up now.

In my next post I’ll get back to opportunity cost and bring this issue of motivation into that discussion.