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Asset-Based Lending: The Cost of Capital v. Opportunity Cost

Asset-Based Lending: The Cost of Capital v. Opportunity Cost

In the world of Asset-Based Lending (“ABL”), Accounts Receivable Financing and Factoring, many times the first objection we hear from a potential prospect is, “I can’t afford alternative financing because it’s too expensive.”  While that is certainly a valid consideration, it is only one facet of the decision making process when contemplating financing options.

Asset-Based Lending typically becomes an option for a small business when they are unable to secure all the financing they need from their local bank.  Perhaps the company is a start-up and hasn’t established sufficient operating trends for the bank. Maybe the business had a rough year and reported very little net income or even a loss.  Or it could be the bank is willing to provide a line of credit, but the company needs a larger credit facility because of spiked growth.

While alternative lending is usually more expensive than traditional bank financing, it unquestionably is less expensive than taking on an equity partner or securing a Fintech (online) loan.  Additionally, many small businesses do not realize that Factoring or Asset-Based Lending is typically less expensive than merchant fees paid for accepting credit card payments from customers.  For example, let’s say a company invoices their customer $10,000 and the customer pays that invoice by credit card on invoice day 30.  Merchant fees to accept that credit card payment likely range from 2.5% – 3.5%, meaning that the fee on that payment was $250 – $350.  Using an Accounts Receivable Line of Credit, the business would have been able to borrow against that $10,000 on invoice day 1 and the fees for an invoice that is open for 30, 45 or even 60 days would most likely be less than the merchant fees.

When considering Factoring or Asset-Based Lending, it’s important to not only look at the financing cost, but also to examine the OPPORTUNITY COST of not securing adequate working capital. We have spoken with numerous companies over the years that have turned down new projects or purchase orders because they did not have ample working capital to finance the new business.  Instead of turning away the new work, the company pays a small fee (maybe 1.5% – 2.5% of an invoice).  Assuming the company has gross margins of 15% or more, the financing fee is a no brainer…especially when contrasted with turning down the new order and earning a gross margin of 0%! The additional availability generated by an ABL or Factoring facility may also allow a company to take advantage of vendor discounts; mitigating or even eliminating the financing cost.

Next time a growing small business tells me that they cannot afford to use Asset-Based Lending, I may very well ask them, “How can you afford not to?”

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