Although debt factoring looks like a handy solution to generate quick cash-flow, an in-depth investigation reveals that debt factoring has advantages and disadvantages.
If inherent disadvantages might make a business think twice about resorting to such a service, advantages are also more diversified than one would think.
Here’s a comprehensive list of the pros and cons.
I) Advantages of debt factoring
Debt factoring releases immediate cash, saves time and resources, brings total peace of mind, frees working capital and ultimately improves customer management.
1) Releases immediate cash
First and foremost, a debt factoring plan means that the business which delivered the goods or services receives the actual funds claimed with the invoiced almost immediately, regardless of the capacity of the end client to pay for the bill. Funds can be used to carry any necessary business operation instantly.
2) Saves time and resources
With a factoring plan, a company no longer needs to spend time and divert resources to the tedious, unpleasant and time-consuming tasks of invoice claiming and payment collection. Also, the cost of the factoring service may not be as high as one thinks, as the competition in this sector is quite frantic.
3) Frees ongoing working capital
Businesses which use factoring enjoy more flexibility. Direct access to invoiced funds make it possible to repay bank facilities and release previously pledged security.
4) Brings total peace of mind
If the factoring service plan includes bad debt protection (known as non-recourse factoring) that is, a true credit option, businesses will not even need to worry about their clients honouring their debts at all.
5) Enable better customer management
It is also part of the factoring provider’s job to credit check potential customers, so that businesses are more likely to trade with customers that pay on time.
Customers will respect the factors and will be more prone to pay quickly.
II) Disadvantages of debt factoring
Besides the fact that such financing solutions are usually exclusive to B2B commerce, disadvantages of debt factoring should not be neglected. They include loss of profit, downgrading of the credit ratio, loss of control of your business’ image with your clients and... more debt.
1) Loss of profit
It should be kept in mind that a debt factoring service comes at a price : usually, a percentage of the factored funds will be levied on the second transfer made by the provider (the one that comes when the end-customer finally pays his bill). This represent a loss of profit.
2) Credit ratio downgrading
The creditworthiness of a corporation resorting to factoring will be reduced, as this system trades receivables with solid debts : book debts will not be available as security anymore.
Access to credit will be reduced.
3) Loss of image control
Businesses using factoring services should make sure of the trustworthiness of their providers, and of their methods. Besides the fact that by principle, some clients will prefer to deal with a goods or services provider directly, businesses should be aware that they place their most valuable asset - their client base - in outside hands at the most crucial time - payment collection. Brutal factors may severely damage the reputation of a company if they use the wrong tactics at the wrong time.
4) Debt factoring means debt
Although not always technically defined as such, factoring means businesses owe funds to their factors. This is ultimately offset by the eventual payment of the end-customer, but if one business wants to terminate a contract with a factor, they will have to pay off any unpaid invoice issued by themselves. And that may add up to quite an amount.
Interested parties should note that opting for invoice financing brings other specific advantages and disadvantages, covered elsewhere in this guide.