- 18 Apr
Factoring Advantages And Disadvantages
If you are looking at using factoring as a source of funding for your business, you may be interested to understand the pros and cons.
Factoring Advantages And Disadvantages
Below I have set out the factoring advantages and disadvantages in simple terms, so that you can make an educated decision.
Improved Cash Flow
The biggest advantage is the improvement to your company's cash flow. As you raise new invoices to your customers on credit terms, they are forwarded to your factoring company, and they make a prepayment (typically 85% of the face value) available to you immediately. This means that you do not need to wait to get paid by your customer, in order to access that cash.
Releasing Working Capital
If you have an outstanding sales ledger of unpaid sales invoices, these pre-payments against all of those invoices can release a large lump sum of working capital, for use within your business.
There are no restrictions on the purpose for which you can use this cash, it could be to make payments to your suppliers, pay off pressing creditors, pay HMRC or invest in expanding your business. One of the benefits of having access to this type of cash is the ability to negotiate settlement discounts with customers. This can lead to an overall cost saving for your business.
Outsourcing Credit Control Activity
A factoring service includes an outsourced credit control function. This means that the factoring company will undertake at least part of the credit control activity for your business. The exact nature of the service provided varies between factors, and it can range from calling your largest debtors through to a fully comprehensive offering, where they chase them all so that you don't have to.
Using such an outsourced service can mean that you do not need to employ a team of credit control staff, or have the burden of undertaking this task yourself. Once you take into consideration the costs associated with employing staff, and running your own in-house credit control system, factoring can be cash positive for your business, as the benefits can outweigh the costs. See our factoring cost benefit calculator for details.
This service may be even more useful if you sell to customers based abroad. Export factoring includes a credit control service for your foreign customers. This removes the need for you to employ staff with language skills and knowledge of local customs, in order to deal with overseas customers.
If you select the right provider, the credit control service can lead to an improvement in your company’s debt turn. This is the speed at which your customers pay. Using a professional service can mean that days can be shaved off of your debt turn. The advantage of this is twofold. Firstly, it means that cash is received quicker into your business, improving your cash flow. Secondly, the faster your customers pay, the less your discount charges are likely to be for using the funding from the arrangement.
Protection Against Bad Debts
One of the options available is bad debt protection. This can prevent your business suffering the impact of a customer becoming insolvent and failing to pay you for goods or services that you have already provided.
Other Outsourced Services
Many providers offer other services that can be added onto their basic facilities. These can include functions such as payroll management. This means that your staff payroll is handled by a third party. This can once again, significantly reduce the administrative burden on your company, and staff.
Confidentiality To Appear A Larger Organisation
If you choose to use confidential factoring, you can enjoy all of the benefits of a factoring service but have it delivered in the name and branding of your company. This will make your business appear to your customers as a larger organisation.
Flexibility To Select Transactions
You can opt for a selective option so that you pick and choose the invoices to be funded. This allows you to control the costs and avoid any minimum fees.
To balance the advantages, these are the disadvantages.
There is of course a cost to using a factoring arrangement. However, as explained above, this can be offset against the benefits generated in many cases. In some cases, you can end up with a positive contribution from using such an arrangement.
There are also many different ways of structuring the fees. They are fully inclusive arrangements, with a single fee structure. There are selective spot factoring arrangements, whereby you pick and choose the invoices to be funded. And there is the more traditional option whereby the fees are charged according to the volume of business transacted, and the amount that you borrow.
It must also be observed that there are significant differences between the fees quoted by different providers, for the same business. In our research, we have found a 165% difference between the cheapest factoring quotes and the most expensive, for the same business.
There is an element of setup required for an arrangement. This will include notifying your customers of new bank details for payments to be sent to. Many of the factors have processes in place to help you with this set up work.
Loss Of Interaction With Customers
Some businesses worry about the loss of interaction with customers if a third-party is undertaking their credit control activity. Whilst this does reduce the work burden on your company, you may prefer to use an invoice discounting service whereby you retain the credit control function in house.
The key piece of security required is the book debts of your company. Whilst this may seem obvious, once you have placed them to a factoring company, they cannot be pledged to a third party in order to support another form of lending.
It is also common to require personal guarantees, although this is not always the case. Often the key reason for taking a personal guarantee is to ensure that no fraudulent invoices are submitted for funding. However, you should always seek legal advice before providing personal guarantees.
The Balance Overall
When you look at the balance of advantages and disadvantages overall, it is often the case that the advantages outweigh the disadvantages of factoring. There can be significant cash flow benefits, and other peripheral benefits to using such a service that can completely offset the costs in some cases.