Monday, February 18, 2013

One Accountant's Perspective: Bulk Order

Dear Tran:
I have a small business that has been in operation for about 6 months. I have about $7,000 dollars in gross sales per month. I offer a product that currently costs me $24.00 and I sell it for $30.00. This price is pretty fixed due to other competition.

I found out I can purchase a crate of this product from China for $50,000. This amount equates to $18.00 per item (substantial savings). At my current rate it would take me about 1.5 years to sell the entire inventory. I do not know much about loans and getting capital (started the business with $300 ) so any suggestions you may have is appreciated. I did a few calculations and it looks like a 2 year loan even at 20% would save me $9,000 per year. But where do I get a loan from? Or maybe my calculations are wrong?

I applied for a business/personal loan from my local bank, but as I expected I was denied as I do not have any equity.

What are my options? Should I go with this plan?

To be honest, your options are limited by several factors. First, being that it takes roughly 1.5 years for you to move the entire shipment, while the bank has to wait 2 years for full repayment -- that is assuming everything goes according to plan.

So the turnover rate is not in your favor. But do not be disheartened just yet. A small business loan is possible if you have a working and fully written business plan. Most bankers will listen to your idea and make a personal judgment on whether your ideas are feasible or not. A written business plan will always help that along.

Another thing you can try and do is to go through a third party. An accountant who knows your businesses would be a great person to approach. They are likely to have contacts with banks and bankers that trust their judgment and thinking. Thus, you are using their credibility to get a loan.

One more possibility is to approach the company selling these items directly. See if they would extend to you a credit line as long as you moved the items and sold it for them. Most companies will agree to extend this courtesy if you are able to sell the products and pay them on time -- just do not ever miss a payment or that trust will disappear.

On a personal note, I would recommend finding investors. At a 10% per year return, you can find some decent investors who are willing to go into the business with you. Plus, a short-term investment is great for those just wanting to get their feet wet so that gives you a wider range of investors to pick from.

As an accountant, I would advise against such an idea. While it is true that you would go from a gross profit margin of $6.00 to $12.00 if you made the switch; you would also be incurring a large risk to your business. There are several factors to consider when looking at such a bulk order and one from a different supplier.

The first of which, is it the same quality material. It is possible that your $24 product is built more reliably than the $18 product item. Thus, a switch might cause more faults and defects to occur. Which would ultimately result in higher warranty costs -- if you offer warranties -- and lower customer satisfaction.

Second, if the items are comparable then, you are faced with having a huge amount of your money invested into your inventory that is staying on your shelves for nearly two years. That is money you can be spending on advertising, customer service, expansion, investing, and the list goes on -- the opportunity cost could potentially be too high.

For example:
  1. $50,000 for the bulk order at $18 per unit equates to 2,778 units
  2. 18 months (or 1.5 years) to move all 2,778 units, means you must sell 154 units per month to stay on schedule
  3. (2,778 units on hand - 154 units sold) = 2,624 units on hand
  4.  (2,624 units on hand x $18 per unit) = $47,232 inventory costs
  5. If interest is at 0.0083% (10% per year), your opportunity cost is at: $47,232 x 0.0083% =$393.60 per month (or $6,691.20)

This means you would lose roughly a month worth of sale by purchasing this bulk order -- despite the more appealing pricing.

Lastly, you are potentially facing another problems with obsolescence. The product could be replaced with a better product or you could have issues liquidating the items in the event you need cash. Overall, I would recommend against such an idea.

I hope this helps!

Tran Nguyen - Accountant