Determining When To Use Factoring

An important part of making factoring decisions involves knowing when it makes sense to use it. Some companies wait to long to use factoring, and they miss out on returns and needlessly risk business failure. Other company's factor too often and could save money by factoring less.

In this section we will discuss some calculations that can be used to determine when you should factor.

The decision to factor is driven by knowing what a company's minimum cash balance should be. To use the analysis in this section you will first need to develop a cash flow statement. This is needed to know what your cash balance is in any given month.

Then you can use the following equation to determine what your minimum cash balance should be:

In this equation, the variables are defined as follows:

• CB = cash balance (this is the minimum cash balance)
• i = the interest rate offered by the factoring company
• nCF = the average negative cash flow
• r = the rate of return on assets

The i variable is simple to figure out. It's simply what you will be charged as a rate from the factoring company you are working with. If you have created a cash flow statement you can find nCF (average negative cash flow) by simply taking the average of the total cash outflows in the cash flow statement. To find the rate of return on assets you will need to construct a balance sheet. The rate of return on assets is found taking your total assets and dividing them be net income.

Once you have these individual numbers, you can enter them into excel.