on Mar 23rd, 2007Factoring in the Fashion Business: better than going to the bank?
by Alfred Hedaya
Factoring has been the preferred method of financing for apparel firms for decades. As opposed to bank financing which depends on profitability demonstrated by financial statements, factoring can provide needed working capital based on a companies sales.
A major challenge the fashion industry presents to banks is the relative unpredictability of the business. For example a company that had relatively steady sales can experience a sudden growth spurt for any number of reasons including a new hot product, opening up a new major account, or finding a new market or region to sell into. In this scenario a bank will not be able to meet the rapidly changing needs of the business.
Other reasons for unpredictability can be seasonality, a change in the market, or worst case; a downturn in the economy.
Since factors are financing sales (in the form of accounts receivable) and they are familiar with the ups and downs of the fashion business they are more flexible and they are able to deal with fluctuations in the market and in the business itself.
How does it work?
Let’s look at the following example of a fictitious high end ladies apparel company that was experiencing a tremendous growth spurt. With financial support provided by the factor it is able to increase its sales volume by 150% in one year.
· New company in business for 1 year
· $600,000 in annual sales
· Average sales $50,000 per month
· Average collections is 60 days
· 50% gross profit margins
· 80% advance from factor on accounts receivable
· 4 shipping cycles per year (Fall,Holiday,Spring1, Spring2)
· All funds advanced by factor go to the purchase of new merchandise
The company starts factoring its receivables in the beginning of its second year. It starts with $100,000 in Accounts Receivable and gets $80,000 in initial funding from the factor:
Fall – With the initial $80,000 advance on its receivables the company can purchase an additional $80,000 worth of merchandise at cost which it can sell for $160,000, when the company ships the $160,000 in merchandise it generates $160,000 in A/R and the factor advances $128,000 (80%) to the company and the cycle continues in the following manner:
Holiday - Purchase additional $128,000 worth of merchandise and sell for $256,000, which upon shipping generates $256,000 in A/R and factor advances $204,800
Spring - Purchase additional $204,800 worth of merchandise and sell for $409,600, which upon shipping generates $409,600 in A/R and factor advances $327,680
Spring 2 – Purchase additional $327,680 worth of merchandise and sell for $655,360, which upon shipping generates $655,360 in A/R and factor advances $524,288
The following are the results after the first year with factoring:
· The company achieves sales of $1,480,960, almost tripling sales from the previous year.
· At the end of the year the company has $524,288 in funds available to purchase merchandise to support $1,048,576 in sales going forward.
· Following the same pattern, in the second year with factoring the business will be on track to support $9,705,618 in sales.
The fact is that there are very few financing sources other than factoring that will enable a company to grow sales in this manner.
If there are any questions regarding this article or factoring in general please contact:
Alfred Hedaya The Hedaya Capital Group, Inc.
32 Broadway, Suite 1211, New York NY 10004
Tel: 212-233-0044, Fax: 212-233-0220
Alfred@hedayacapital.com
