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Structure of Profitability Comparisions between Strategies

Business Strategies

As an example of Alternative Financing, compare a business now doing "Business as Usual" with the same business using two of the strategies of the Cash Flow Industry, namely, "Accounts Receivable Financing" and "Purchase Order (PO) Funding." In general, the business invests its working capital into the Cost of Goods Sold (COGS), waits for the Customer to pay, recovers the capital invested, and makes a profit. The COGS is a variable cost which includes both "Hard Costs" (materials, shipping, receiving, equipment, etc.) and "Soft Costs" (direct labor, overhead, etc.). Therefore, the typical transaction used by most businesses is based upon a standard model of delivering Goods and Services to Customers. For instance, the Customer issues a Purchase Order for Goods and Services to the business. The business then must buy raw materials and other merchandise for resale (or for manufacturing) from vendors/suppliers. After which, the business delivers the Finished Goods and Services to the Customer and waits for the Customer to pay the invoice that accompanied the delivery. This represents a model business transaction which has a working capital requirement and may have a potential cash flow problem.

The "Sample Business Transaction" used in this quantitative analysis below has the following characteristics:

1) The COGS are 60% of the invoice amount and are paid 15 days prior to invoicing the Customer.

2) The "Hard Costs" represents 85% of the COGS (or 51% of the invoice amount).

3) The "Soft Costs" is 15% of the COGS (or 9% of the invoice amount).

4) Business invoices the Customer when the Finished Goods and Services are delivered.

5) The Customer pays invoices within 15, 30, 45, or 60 days (working capital is required for 30, 45, 60, or 75 days).

Summarizing the delivery model being analyzed, requires the business to have access to working capital when the business purchases supplies from vendors, and has to pay for the COGS 15 days before invoicing the Customer. The business submits an Invoice to the Customer (net 30 days). The example below analyzes the internal rate of return (annualized percentage rate) based upon the Customer paying the Invoice within 15, 30, 45, or 60 days after delivery of the Goods and Services. Therefore, the working capital investment is normally "On The Street" for a total of 30, 45, 60, or 75 days. The Internal Rate of Return (IRR) of the working capital represents a measure from which different financial strategies can be compared. For simplicity purposes, a 60% COGS (the business’s working capital requirement) and 100% Sales Revenue (Business Invoice and Customer Payment), is used throughout the quantitative analysis.

The IRR analysis below compares four (4) primary and two (2) supplemental financial strategies for delivering Goods and Services to the Customers where the business funds the working capital required for transactions. The first strategy is titled "Working Capital Funded by the Business" (the normal method of doing "Business as Usual"). The second strategy is titled "Working Capital Funded by A/R Financing" (this represents a 100% Alternative Financing strategy and implies the business supplies all required working capital like the first strategy). The third strategy is titled "Working Capital Funded by PO Funding" (this represents a 100% Alternative Financing strategy and implies that the business furnishes a small amount {15%} of the working capital requirement and the Purchase Order Funding company supplies the balance {85%}of the requirement). The fourth strategy is a combination of both forms of Alternative Financing, namely, Purchase Order Funding and A/R Financing.

The final two (2) supplemental strategies are separated from the first four (4) primary strategies because they involve the business using Debt Services to fund the "Hard Costs" of COGS. The fifth strategy is just like the first strategy except all the "Hard Costs" associated with the business transaction is furnished by borrowing money from a financial institution and is titled "Working Capital Funded using Debt Services." The sixth strategy is a mix of ordinary Debt Services and Alternative Financing and is titled "Working Capital Funded by Debt and A/R Financing."

Structure of Profitability Comparisons Between Strategies

The six (6) strategies are first defined and then several financial relationships are determined in various ways that allows comparisons between the strategies being analyzed. All the analyses are presented for a range of accounts receivable, namely, 15, 30, 45, and 60 days. The analysis for each strategy is then divided into several basic sections, namely:

Working Capital Reduction Mechanism

This section is provided for strategies employing financing, and it represents the mechanism that explains the reduction of the working capital requirement the funding provides. The working capital reduction mechanism always compares the strategy being deployed with the working capital requirement of Strategy 1. The New Working Capital Requirement represents the revised investment in the transaction using the financing strategy.

Business Transaction Definition

This represents the definition of the business transaction incorporating the strategy being deployed. The definition includes the percentage amount allocated for production costs (working capital investment), sales revenue, and the timing between the cash outlays and the cash receipts.

Business Transaction Profitability Summary

This summarizes the profitability measurements of the business transaction, including the Return on Capital, IRR, Working Capital Reduction percentage, and the New Working Capital Requirement. Each strategy has the Return on Capital Ratio resolved. This ratio (Return per New Working Capital Requirement) represents a profitability measurement of the strategy’s ability to provide a return on the investment, e.g. a ratio of 1.67 indicates that $1.67 is returned for every $1.00 invested. Strategies that have the highest ratio are the most profitable and the most desirable.

Two Transaction Business Profitability Summary

This section is provided for strategies employing financing, and it demonstrates the total gross profit for two (2) consolidated business transactions (2X) for the strategy being deployed. (It is assumed that most businesses can operate with twice the sales revenue using the same basic fixed administrative overhead and facilities for a short period of time. The additional variable costs associated with the transaction is already in the working capital requirement.) The consolidated gross profit for the strategy being deployed is always compared with the gross profit of Strategy 1. The gross profit is summarized for the strategy using financing by revealing the 2X Number of Business Transactions Deployed that can be supported by the funding for each accounts receivable, the 2X Net Gross Profit (Funding Fee Removed), the 2X Extra Working Capital Available for fixed costs, and, the Total 2X Extra Capital Accessibility (less 40% 1X Gross Profit). The total capital accessibility to capital is a measure of the worthiness the financial strategy being considered.

Working Capital Profitability Mechanism

This section is provided for strategies employing financing, and it provides a chart and a table that displays the total gross profit for consolidated business transactions (1X, 2X, 3X, 4X) for the strategy being deployed. The data contained herein provides the basis for the Two Transaction Business Profitability Summary section above.

Strategy Summarization

This section displays a chart and a table that provides a visual and graphical representation of the strategy. The actual working capital reduction displayed on each chart is a statistical representation of the value and net worth the strategy contributes. Please note in each and every case, the value and net worth of the strategy is less than the value and net worth shown in Business Transaction Profitability Summary section above, because the statistical methodology assumes that no business can operate with 100% efficiency. The statistical methodology is summarized by the Profitability Comparison following the first four (4) strategies and the last two (2) strategies.

Please observe that the Alternative Financing Rates used in these strategies are representative and leaning toward the high side. Actual financing rates could be much lower, and many businesses do indeed qualify for lower rates and higher advances, because they have very credit worthy customers, have high volumes, and have larger invoices.

3W Internet Corporation commits its resources to support every alternative financial specialty that is described in this primer. Although all the computations featured in this document have been thoroughly checked and tested, there may be some functions that rely upon other financial concepts methods, strategies and ideas using software, and protocols not developed by 3W Internet Corporation. 

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