There are a number of pros and cons which come with invoice factoring. The following weighs up the positives and negatives of this form of finance to help you decide if it’s the right financing solution for your business.
Pros
Speed
Invoice factoring is a uniquely efficient way to secure considerable sums of money quickly. Mmost invoice factors will provide you with your advance within 24 hours of an invoice being created. It’s easy to set up, with most providers approving applications within a week.
No need for security
Unlike more traditional forms of lending and borrowing, there’s no need to put up any additional security beyond the invoice being factored (unless otherwise agreed). The financier knows that your customers are obliged to pay their bills, meaning the outstanding invoices serve as collateral themselves.
External debt collection
Invoice factoring is unique in that the lender almost always assumes total responsibility for debt collection. It’s in their hands to chase late-paying customers and deal with demanding clients refusing to pay. This alleviation can free up valuable time and resources in your company, to be directed to other ventures or plans for growth.
Lower risk
Invoice factoring is also typically a lower-risk form of borrowing, both for your business and for the lender. As a business owner, you are safe in the knowledge that the money you owe is coming in in a matter of weeks or months, removing the pressure of taking on a long-standing debt.
For the lender, they can see where their money is coming from, and they have control over chasing the customers and having their money returned. A lower risk for the lender means this form of finance is typically cheaper than other short-term finance options available on the market, such as business overdrafts.
Flexibility
Factoring is also a flexible form of finance. As your sales ledger expands, or even if it contracts, it’s quick and easy to change your factoring facility to match.
Cons
Third-party involvement
Many clients are naturally distrusting of third-party involvement, and with invoice factoring, there’s not usually a way to hide it. Customers are required to pay the lender directly.
Such involvement can damage your customer relationships, which is worth weighing up when it comes to key clients. It’s also a good idea to vet your lender’s collection methods, to see how obtrusive they are when it comes to chasing or communicating in regards to invoices.
Higher fees than discounting
As the factor assumes control of your sales ledger, they’re also taking on more work, which typically translates into increased costs you pay.
Exclusion from other finance – Borrowing in this way can exclude you from other forms of finance. If you’re receiving invoice factoring, you may be ineligible for different types of borrowing, so it’s worth considering whether you can manage without other sources of finance.
Tied in
Invoice factors typically offer long-term contracts. Some contracts may lock you in for 24 months or more, with significant early termination fees. Many contracts oblige you to sell all of your invoices to your factor, even in periods where you aren’t experiencing a cash flow shortage.
Using factoring in times where you may not truly need it means that you could be unnecessarily losing profits, owing to the factor rate, services fees and any additional charges. Invoice factoring can, therefore, be unsuitable for businesses with seasonal fluctuations that are able to manage their cash flow in busier periods.
Case study
If your still not sure quite how factoring works in practice, here’s a quick case study. A Sussex based logistics firm is looking to expand. The company is profitable but struggles to reconcile its cash in against cash out to leave any working capital left to implement its strategy for growth. Late payment is part and parcel of the logistics industry and coupled with the pressures of vehicle maintenance, fuel prices and irregular payroll commitments, maintain its cash flow has become a serious problem.
To help, the firm approaches a finance factoring company. The factor investigates the company. The logistics firm is reputable in its local area and has recently won contracts for some large national projects. One of their clients is the local council, and it also has many long-standing customers with good reputations.
The factor considers the company low risk in light of its creditworthy customers and sizeable invoices. The factoring company offers the company a £300,000 factoring facility. Within several months, the business sees exponential growth owing to its boost in purchasing power. The company expects to triple its turnover in the next two years, thanks to its asset-based lending providers facility.
