Debt factoring advantages and disadvantages
Debt factoring is the sale of your business invoices to a factoring company. This is usually done at a discount. It is then the job of the factoring company to process the invoices.
There are a many debt factoring advantages and disadvantages, but the number one reason why many businesses use debt factoring is the swift injection of cash to improve cash flow.
Discover the advantages and disadvantages of factoring for your business below.
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Invoice factoring advantages and disadvantages
For the business owner, there are a range of advantages and disadvantages to factoring. Understanding these points is key to deciding whether debt factoring will be the solution you are looking for.
Advantages of factoring
Invoice factoring offers businesses a range of viable benefits that should be considered carefully during the decision making process. These benefits can help your business to grow, and can significantly reduce your reliance on upcoming payments.
Take a look at the sections below for more information.
Improved cash flow
Primarily, the goal of factoring, and therefore the key advantage, is swiftly raising cash. It is a way of getting the money your customers owe you, without waiting for them to actually complete the transaction.
Although you will be expected to sell the invoices for a discount, this needs to be considered in the wider context. You won’t be losing time, money or resource on administering and processing invoices.
Start-ups, small businesses, and entrepreneurs need cash injections to help them grow. It can be the difference between seizing an opportunity and allowing for expansion, versus stagnating and losing out. Therefore, receiving cash injection to improve cash flow is the key advantage of debt factoring. You could have cash in your hand within just a day or two.
Ability to make quick purchase decisions
If you urgently need to make supply purchases, make repairs, or get new equipment, factoring is an excellent way to release the required funds.
Should you be presented with the opportunity to take on a new client or a large order or project, you may need to quickly expand in terms of staff and capacity. Debt factoring can boost your working capital.
Taking the business to the next level
Entrepreneurial businesses can be hampered by their inability to create new product lines or offer additional services, which will ultimately benefit the bottom line, because they simply do not have the cash available.
Shorten the cash flow cycle
Many smaller businesses struggle because of the expected and normalised time between work or order completion, and the payment being made. This time lag can pose significant knock-on problems. One of the advantages of debt factoring is that it can shorten that cycle, and get payment into your hands sooner.
Bad debt protection
One of the key advantages of factoring is that it takes some of the risk of bad debts out of your hands. To do this you will need to choose non-recourse factoring, and this will be reflected in the ‘discount’ – where you will pay higher factoring fees as you are mitigating all risk. However, this protects your business from any loss if a debtor does not pay.
Cost effective administration
Smaller businesses, where staff tend to take on several roles, can quickly find that financial administration becomes a time-consuming and resource-eating task that does not pay. By handing over the administration of the invoice to the debt factor it will free up valuable labour time which can be used grow the business. This can also prove worthwhile to your bottom line by reducing significant administration overheads.
Debt collection cost effectiveness
Should you be in the position of needing to get debt collectors on board, you will be paying a hefty fee, often considerably higher than 20% of the value of the debt. With factoring, the fees are significantly less and the factoring company will take care of unpaid invoice collections.
Peace of mind
As a business owner, debt factoring can bring peace of mind that your cash requirements will be met, and that you are in a position to meet the needs of your business.
Viable finance option
For those businesses that are unable to attain a bank loan, debt factoring is a viable finance solution.
Disadvantages of factoring
Alongside the advantages of debt factoring there are some notable disadvantages of factoring to take into consideration.
The disadvantages of factoring can include:
Slightly reduced the bottom line
Ultimately, debt factoring companies charge you factoring fees for taking on the risk and collecting the payment of unpaid invoices. As a result, you stand to make a reduced amount from your invoices. However, the benefits of debt factoring far outweigh this small loss.
Some business power is given to a third party
Factoring companies tend to have certain expectations about the way businesses are run. Generally speaking, they are not big risk takers. Therefore, they may insist you change the way you do things, including the types of customers you have or even staff you have on board.
Customer service and reputation
As a business owner, you will understand the vital importance of maintaining an excellent reputation with your customers. One of the disadvantages of factoring is that you lose control over the invoice payment process, and a customer might not like the way your chosen factoring company go about their payment collections.
However, there are options available whereby the invoice factoring company’s involvement can be managed effectively to maintain good relations with your clients. In some cases the involvement of the factoring company can almost be disguised.
Possible liability for bad debt
It will depend on the terms of your factoring agreement, but under some agreements (such as recourse factoring arrangements), unpaid invoices can come back in your direction. This is particularly important to note if you have a large number of invoices due from customers with poor credit ratings.
However, you are able to mitigate the risk of this by effectively managing the type of invoices that you factor. For example, it may be best not to factor invoices from a client that has a very bad credit rating. Invoice factoring companies will work with you to identify the best invoices to factor which mitigate risk for both you and them.
Considering the advantages and disadvantages of factoring
When you consider whether debt factoring will work for your business, it is important to consider the advantages and disadvantages of factoring. You must do this before signing any debt factoring agreement.
Understanding the advantages and disadvantages of factoring puts you in a much better position for negotiation, and indeed maximising the advantages of factoring for your business.