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Case Study for Factoring & Letters of Credit

By Stephen Perl, MBA, MS

In 2008, a lighting manufacture named Lighting Plus began designing and manufacturing its own line of flashlights and solar products decided to start selling in the market U.S. Their plan was to sell to wholesalers and directly to major retailers. Besides sound management and execution, they needed two main items … Sales and Working Capital.

Opportunities:

Initial opportunities to expand presented themselves, and they landed their first major catalog company. This catalog company was their main client for the first 6 months while they located new clients and new sales reps to sell and promote their goods. In 2009, the lighting company’s orders started to pickup and they realized that their suppliers need advances for manufacturing some of their popular products that they did not make in house. They began wiring 30 to 50% advances but this quickly became impractical because the deposit amounts were large and this process was locking-up their valuable working capital. They also realized that their targeted client base all required 30 to 90 terms on their invoices before making payment.

Current Working Capital situation:

Lighting Plus had $200,000 in working capital at the start, but the funds were initially deployed as shown below which prevented further grow:

Lighting Plus  
Working Capital WITHOUT new financing as follows:
Office setup
$20,000
Monthly Payroll
$20,000
Factory Deposits
$60,000
*Receivables Outstanding
$130,000

* Note that a 30% gross profit has been built into the receivables

As you can see, with only modest sales, all of Lighting Plus’s working capital was used.

Choosing Equity or Debt to Raise Capital:

Lighting Plus needed more capital and there was a choice…to raise more equity for the company (the price being less control and % ownership in the company) or finding a lenders that could provided the needed working capital.

The Decision:

Lighting Plus management decided to find a lender that could provide a combination of lending and factoring. Traditionally, a company would like to get a simple line of credit based on its assets from a bank and be done; however, Lighting Plus was a new company without 3 years of profitable tax returns. Even if a line of credit at a bank was established, it would be limited based on current equity to debt ratio which would greatly limit the line of credit. Lighting Plus needed a line of credit that could grow with their fast growing sales.

The Result:

Lighting Plus established a line of credit with 1st PMF Bancorp that provided a solution for their fast growth through two key financial products. First, a PMF Bancorp established a line for a Letter of Credit up to $400,000. Second, PMF also established a factoring line to convert all outstanding receivables to liquid cash (i.e. the $130,000 in outstanding receivables above would be converted to approximately $104,000 or 80%).

Lighting Plus no longer had to make deposits to suppliers for 30% to 50%. Instead, Lighting Plus used its new Letter of Credit line to purchase $400,000 in new inventory and generate $520,000 in new sales from that inventory. Additionally, the $520,000 in new sales/invoices were converted into $416,000 in instant cash by using PMF’s factoring line facility.

Lighting Plus  
Working Capital WITH new financing from PMF Bancorp’s LC & Factoring Line as follows:
Office setup
$20,000
Monthly Payroll
$20,000
Factory Deposits
$400,000
*Receivables Outstanding
$520,000
CASH converted from receivables $416,000 (new cash from PMF line)

With PMF Bancorp’s financing, the direct financial benefits were that Lighting Plus was able to increase its sales by 400%, and its cash position from $0 to $416,000.

The more subtle and indirect benefits were that Lighting Plus able to transition to a more sophisticated and safer way to conduct business. By using Letters of Credit (LC), Lighting Plus no longer had to worry about their supplier being paid before goods were delivered. There were also inspections and certifications built into the LC process that insured paid goods were delivered according to their specifications. The factoring/receivable financing also made the collection process more efficient and safer because customers paid more timely as they were afraid to have PMF report them as late payers. Factoring also allowed Lighting Plus to credit insure various clients as they saw fit.

In 2010, Lighting Plus is set to do approximately $10,000,000 million in sales. Their model has been a typical model at PMF Bancorp for approximately 30 years.