The advantages and disadvantages of debt factoring
Debt factoring involves a business selling their invoices to a third party at a discounted price in order to bypass the hefty waiting times which are associated with invoice payments. It has become especially popular with SMEs due to its ability to provide them with instant access to capital and speed up their processes. Here are some of the main advantages and disadvantages of using this service.
The greatest advantage to debt factoring is its ability to improve cash flow, as it allows businesses to instantly release the cash value of their invoices. This means that they can instantly use the cash to operate and reinvest in the business.
It’s incredibly important for a business to have good cash flow, as it is key to day-to-day operation and growth. It also increases finance for trade, often allowing the company to take on more work since they have access to the necessary funds to complete more jobs.
One disadvantage to debt factoring is that it reduces overall profit for businesses. The factor always charges a percentage of the overall invoice value (usually between 1-3%), and on bigger contracts this can turn out to be quite a hefty sum.
The loss of profit, however, can be counteracted by the saving of time and resources facilitated by improved cash flow. The administration and resources needed to manage and chase up invoices can be expensive, so debt factoring can also free up time to use elsewhere in the business. This leads to greater overall efficiency and ensures that every resource is being used wisely.
However, chasing up payments is outsourced with debt factoring services, so you have less control over your sales ledger. This means there is no confidentiality either, and your clients will be aware that you are using such services.
Whilst debt factoring provides instant working capital, it also leads to short-term debt. Whilst this should be paid off as soon as the customer pays the invoice, it can lead to bad debt if there are problems in between.
Should a customer dispute the invoice or end up paying late/not at all, it could cause complications to the business, since it is in debt to the factor. Who eventually pays the price for an unpaid invoice should be agreed before the money is lent by the factor, but a simple credit check of customers can go a long way in preventing problems with payments further down the line.
Ultimately, debt factoring leads to accelerated growth, which can see businesses expand rapidly (provided they reinvest the factor’s money wisely). A growing business is a healthy business, and it is likely that those using debt factoring will have a decent level of finance for their trade and operations. Once growth has really begun to take hold, it is likely that debt factoring will be needed less and less as the business builds up its own funds and takes on more work.
Debt factoring can be useful in smoothing out business finance issues as well as stimulating cash flow and growth. For a small cost, it allows all types of business to instantly access funding for their daily operations, as well as for reinvestment purposes, and in some cases can even make the difference between success and failure.
It’s quick and easy to access funds, which means you can get the cash flow you need to get on with business. With MarketFinance, you get:
- Fast funding: quick funding decisions and set-up
- Hassle free experience: easy to use digital interface
- Help in real-time: personal customer support
- Straightforward costs: no hidden fees