Financial Discount Rates for Colorado Pharmacy Cash Flow Instruments

By Brad MacLiver
Authorship and profile at Google


When a Colorado (CO) pharmacy is considering selling a cash flow instrument such as the pharmacy’s receivables, or a pharmacy business note, the price the pharmacy owner in Colorado receives will reflect how much time is involved before the Buyer/Investor/Funder of the cash flow instrument will recoup his principal investment and the desired rate of return the Investor needs to make it desirable to take the risk of buying the pharmacies cash flow instrument.
                   
To entice an Investor to shift the risk of holding the cash flow instrument from the pharmacy owner in Colorado to the Investor, there is typically a financial incentive for the Investor. The incentive is the rate of return, which is required to compensate for the Investors perceived risk. The risk is based on the credit of the cash flow instrument’s Payor, previous payment history, seasoning, interest rate, and other variables. Discount rates may change depending on the circumstances of the cash flow instrument, the economy, etc.

If the CO pharmacy owner or an investor could take the cash flow instrument to the bank and cash it in at face value, this would mean the asset would hold more value. This can’t happen, however, so the risk of holding the cash flow instrument makes it worth less than its face value.

Time Value of Money:
When cash has more value to a dollar today instead of tomorrow, this is known as Time Value of Money (TVM). Most business people know about TVM and how it is fundamental to both personal and corporate decision making, but in order to ensure that we are on the same page, let's cover the basics of TVM.

TVM assumes that money earns interest over time. Therefore, as the cliché says time is money, and because of this we can compare money at different points in time that have different values and call them equal.

An example: If $2.00 today earns 10% interest, it will be worth $2.20 at the same time next year. Therefore, $2.00 today = $2.20 next year = $5.40 ten years from now.

Within the same reasoning the reverse is true. An investor will not pay $2.00 today for a dollar that won’t be collected until next year, or 10 years from now. Today’s dollar will be discounted to reflect risk, inflation, the strength of the economy, etc.

Along with interest rates and principal amounts, a cash flow instruments such as Pharmacy Business Notes, are originated with a certain time period. The TVM can be looked at, as if it were on a sliding scale. The earlier in time the Note is paid off, the smaller the amount becomes. When the Note is paid early, you don’t get to collect the compounded interest amount, which would have accumulated if you had waited the full time period. The Note has already been written and the terms set. Unlike a loan where the rate of return needed to cover the risk is added to the loan amount. An investor cannot go back to the buyer of your business and change the terms of the note. Therefore, the investor looks at the portion of the note, which is going to be purchased and subtracts the rate of return needed to justify the risk. This is called Discounting. The amount of the discount is contingent on the risk.

Example:

If you sell something for a $2.00 with 5% interest, equal payments received over a 15 year period, you would expect to receive $4.16. However, should the note be paid in full in 5 years you will only have collected $2.55. You are not collecting the other $3.11 because you are no longer risking anything (you are not earning it). If you want an investor to advance you the $4.16, you will no longer have any risk because you have transferred it to the Investor. To compensate the Investor for accepting the risk of holding the note, the Investor will discount the note, and pay you an amount equivalent to the time and risk involved.

The price you receive when selling your note will be the discounted rate according to the basic TVM principals minus the amount that allows an investor to justify the risk.                               

If a note is a length of 3, or more years, it may be beneficial for you to sell only a portion of the note. Because the payments from a month in the 5th year will hold less value than payments collected this year, it is beneficial to you to only sell the number of months that you need to obtain the cash that meets your current financial needs. You can always sell more payments at a later date if you need additional funds. Determine what cash you really need and we will calculate the number of months we will purchase to meet your needs.

Although it involves a much shorter period of time, understanding discount rates is the same when selling a pharmacy’s accounts receivables in Colorado.


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Is it Worth Selling a Pharmacy Note in Colorado at a Discount?

By Brad MacLiver
Authorship and profile at Google


When a Colorado (CO) pharmacy acquisition has been accomplished by using the private financing method of a pharmacy business note, the holder of the pharmacy note has the option of selling the pharmacy business note for a lump sum of cash instead of waiting for the monthly payments and taking the risk those payments will always be made. Pharmacy business notes can be sold by using a discounting method. Instead of buying a pharmacy note at its face value, the Colorado pharmacy note will be discounted. Meaning the Investor will pay less than face value due to the risk being transferred from the Pharmacy Note Holder (the note seller) to the Pharmacy Note Investor (the note buyer).

Most pharmacy business note sellers only look at the discount rate and quickly calculate in their head that they are giving up too much money to make the selling of the CO pharmacy note an attractive proposition. However, further analysis needs to be completed before a final decision is made by weighing the discounted amount with the benefits of a lump sum of cash.

1) What is the motivation for selling the Colorado pharmacy note? What are the desired goals? Is reducing the exposure to risk a consideration? Is there a financial decision to pay off debt? Is capital required for a new venture? Are there dreams of exotic vacations or world travel that could be accomplished with a lump sum of cash? How important is it to accomplish these goals? What are the opportunity costs if you don’t have the lump sum of cash to achieve your goals, or invest in something that pays a higher return? Determine investment and family priorities.

2) What is the Current Fair Market Value of the pharmacy business? This is what someone is really willing to pay for the business, and not just an “earnings times x” formula. Real aspects of what is happening in the pharmacy industry must be considered and it is advantageous to have a pharmacy industry specialist in Colorado calculate the pharmacy business valuation.

3) How much cash is immediately required by the holder of the pharmacy note?

4) A pharmacy note in Colorado that is seasoned has more value than a “green” note that doesn’t have a payment history. Are you willing to hold the note for a certain amount of time to allow the business buyer time to prove to an Note Investor the capability of the payor making the payments?

5) Are you willing to sell only a portion of the Note (this is called a “Partial Sell”)? The discount rate can be a more attractive proposition when only a portion of the note is sold and the CO Pharmacy Note Investor is not holding all the risk.

Understanding the Risk for the Note Buyer:
1) Pharmacy Buyer Competency - There is the risk that the pharmacy buyer may not run the business as efficiently as you have, sales drop, and the Colorado pharmacy business buyer cannot meet the payment obligations. Incompetency could lead to late payments, missed payments, or bankruptcy.

2) Pharmacy Industry Changes in CO - Changes caused by influences either within the industry, or regulations governing the industry, can make it increasingly difficult for the pharmacy business buyer to meet the contractual financial obligations.

3) Future Competition - Sales and income of the store may be affected by yet unforeseen pharmacy competition either building in the neighborhood or through mail order.

4) Loan to Value - When originating a pharmacy business note you may be creating financing where there is a “negative loan to value.” Example: the Colorado pharmacy business note is for $300,000, but there is only $100,000 of tangible assets for collateral.

5) Title Insurance – Pharmacy business notes in CO don’t have title insurance that will make good a loss arising through defects of titles, or liens.     

6) Time Value of Money - Where a dollar received today is more valuable than a dollar received in the future.

7) Opportunity Costs - When the selection of holding the pharmacy business note ties up capital and prevents potential financial gains from other investments.

It is beneficial to discuss the options and potential origination of a pharmacy note with Pharmacy Business Note Investor before the Purchase and Sale Agreement is finalized for the acquisition of the Colorado pharmacy. This provides the pharmacy business seller, and future note seller, valuable insight into structuring the pharmacy business note so it can be successfully purchased.

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