Should you Combine Purchase Order Financing with Factoring

One of the most common sales pitches that factoring and purchase order financing companies use is to say that combining factoring and purchase order financing is cheaper - because you are refinancing an expensive transaction (po financing) with a less expensive one (factoring)

In general, this holds true. But like everything, the devil is in the details. Here is one important detail. Combining po financing and factoring, when margins allow, will be cheaper from a TOTAL TRANSACTION COST perspective if:

1. You can only factor enough of the invoice to close the po funding line. This means that in large margin transactions, you factor a partial invoice.

2. The rate differential between factoring and purchase order financing is such that the cost per dollar is cheaper for factoring. This is not always true!

Note that I am talking from a total cost perspective, not a cost per dollar perspective.

This graph shows two transactions at different Gross Margins. One transaction is for PO only, the other one combines PO and Factoring. This transaction assumes the whole invoice is factored (no partial factoring)

(click on graph to enlarge!)

The first conclusion I saw was that in transactions that have a gross margin that is higher than 25%, combining products yields a higher total cost.

Some assumptions for the model:
1. Transaction time - 30 days for PO and 30 days for factoring
2. Factoring rate - 0.075% per day
3. PO financing rate - 0.01% per day
4. Invoice size: $125

Like all models, this is not all inclusive and certainly it's not perfect. But the lesson is the clear - model your own transaction before assuming the "industry truth" that combining products is always cheaper applies to you.

Addendum 11/7/10 - Here is a post to help you better understand the cost of factoring.
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Looking for information on purchase order financing? Read the purchase order finance blog