Accounts receivable factoring is a widely adopted method of business financing both in the U.S, Canada, and around the world. Like any form of financing, it comes with its own set of benefits and drawbacks. In this article, we aim to provide you with a comprehensive understanding of the advantages and disadvantages associated with this service, enabling you to make an informed decision before signing up or utilizing it.
Advantages of Accounts Receivable Factoring:
- Enhanced Cash Flow: Cash flow is the lifeblood of any business, and factoring provides a reliable way for growing B2B businesses to obtain the necessary working capital to sustain and expand their operations.
- Catalyst for Growth: Invoice factoring is closely linked to the creditworthiness of a business's customers. As a business generates sales and invoices creditworthy customers, proficient factoring partners continue to provide the funds required for sustainable growth. This symbiotic relationship unlocks the potential for virtually unlimited expansion, as the business's accounts receivable increases in tandem with its access to working capital.
- Debt-Free Financing: Unlike traditional loans, invoice factoring involves the purchase of business invoices by a factoring company at a discounted rate. Consequently, utilizing a factoring company does not burden the business with additional debt on its balance sheet.
- Stress Reduction: The uncertainty surrounding payroll obligations and fulfilling orders can cause significant stress for business owners. By ensuring a steady cash flow, factoring alleviates the anxiety associated with meeting financial obligations, providing a welcome relief for business owners.
- Startup-Friendly: Startups often lack the lengthy business history that traditional banks require. However, many factoring companies do not impose any time-in-business requirements. As long as a startup has a viable business plan and creditworthy customers, they can find willing factoring partners.
- Efficient Setup Process: Establishing an accounts receivable factoring facility typically takes between 1 to 3 weeks, with some cases experiencing even faster setup times. While certain scenarios may extend the process, factoring remains a financing option that can be implemented relatively quickly to support the growth of a business.
- Dedicated Credit and Collections Support: The failure of a single large invoice payment can have severe consequences for a business. By partnering with a factoring company, businesses gain access to their own professional credit and collections team. Factoring companies continually assess the credit risk associated with account debtors or customers, providing valuable insights to business owners. Additionally, factoring companies work collaboratively with clients to facilitate collections while preserving customer relationships, ensuring alignment with the business owner's preferences.
- Accessible in Challenging Lending Environments: During periods when traditional banks tighten their lending parameters, securing financing becomes increasingly difficult for business owners. Invoice factoring, relying on the creditworthiness of customers, offers a financing solution that remains accessible regardless of the lending environment.
Disadvantages of Factoring:
- Customer Contact by Factoring Companies: When a business factors an invoice, it is typically assigned to the factoring company, necessitating customer notification of the assignment. Although pre-informing the customer and framing it as financing growth usually mitigates concerns, some business owners remain wary of third-party finance companies contacting sensitive customers. To smooth over this transition, account executives work closely with business owners to address any apprehensions.
- Potential Guarantees: Factoring companies often require some form of guarantee due to high advance rates and the prevalence of fraud. Guarantees can take various forms, with personal guarantees and validity guarantees being the most common.
- Setup Time, Not Instant: As mentioned in the advantages, factoring setup is generally quick but not instant. Therefore, it is advisable not to wait until a financial crisis arises before considering factoring. Allowing ample time for setup and preparation is crucial to ensure a seamless transition.
- Ongoing Servicing: Unlike a traditional loan or line of credit, factoring requires ongoing involvement and management. As funding is based on outstanding invoices, businesses often need to submit invoices to their factoring company on a regular basis. While this process doesn't have to be lengthy, it does demand organizational skills and attention to detail.
Bonus:
Cost Considerations: The cost of accounts receivable factoring has significantly decreased over the years. In some cases, the discount on an invoice can be less than 1% of its value. However, it is essential for businesses to weigh the cost of factoring against the benefits it provides. Although factoring is typically more expensive compared to traditional bank loans or lines of credit, the potential for sustained growth and access to working capital should be factored into the overall equation.
Conclusion: Accounts receivable factoring offers a range of advantages for businesses seeking working capital and growth opportunities. From improving cash flow to providing dedicated credit and collections support, factoring can be a viable solution, especially for startups and businesses facing challenges in traditional lending environments. However, it is important to be aware of potential disadvantages, such as customer contact by factoring companies and the need for guarantees. By understanding these pros and cons, businesses can make informed decisions about incorporating invoice factoring into their financing strategies.
Learn More
If you have any further questions about invoice factoring, feel free to reach out to us here at Meritus Capital anytime by email at info@merituscapital.com or call us toll-free at 1-877-648-3709. We have been providing factoring services to businesses across the U.S and Canada for almost 20 years!
