The benefits of factoring to keep your cash flow healthy
What are the advantages of factoring?
Factoring is often the preferred solution for maintaining healthy cash flow. As part of a B2B business, many companies decide to use factoring to remedy problems linked to their customers' payment delays, and benefit from the finances they need to settle their various expenses and investments.
But is factoring really a miracle solution for every situation?
Let's take a look at the advantages and disadvantages of factoring.
Why factoring?
Factoring is a system designed to facilitate the collection of a company's receivables.
In practice, it involves obtaining advance financing for invoices before the due date provided to the customer. The sum in question is granted by a specialized credit organization (usually a bank subsidiary) known as a factor.
However, factoring is only available for B2B business, and therefore does not apply to invoices issued to private individuals.
How does factoring work?
There are several types of factoring (classic factoring, confidential factoring, unmanaged notified factoring, etc.). But the heart of the process remains cash flow financing.
Here are the various stages:
- The company sends the factor a list of customers for whom it wishes to factor.
- The factoring company checks that they are solvent and in a favorable financial situation, to avoid bad payers.
- The customer places an order with the company.
- Once the product or service has been delivered, the invoice is sent to both the buyer and the factor.
- The factor deposits the sum (invoice amount minus commission) into the company's bank account, within approximately 24 hours.
- The customer pays the invoice amount directly to the factor.
The benefits of factoring
Cash advance
By law, invoices can take up to 60 days to be paid. That's a lot of time during which cash doesn't flow into your treasury, while your expenses (salaries, supplier payments, etc.) remain unpaid.
With factoring, you benefit from this money immediately, to make up for the cash shortfall. This technique enables you to better anticipate and plan your future activities.
Protection against non-payment
As we've seen, the factoring company always makes inquiries about your customers' financial health. So you don't have to go to the trouble of finding out who's likely to default.
What's more, if the factoring contract you've signed includes a guarantee against non-payment, you'll be indemnified in the event of a problem, sometimes up to 100% (except in the case of disputes with the customer).
Save time and money on receivables management
Sometimes, receivables management is entrusted to the factor. In this case, you save on the administrative costs associated with these tasks.
You also save a considerable amount of time on debt collection procedures, since the factoring company takes care of verifying payments, monitoring and reminding customers, and so on. As a result, you have more time to focus on your core business.
Flexibility
Factoring offers greater flexibility than overdraft. Indeed, the financial situation of the company's debtors remains the main criterion taken into account by factoring companies. As a result, if the results are less satisfactory, but the customers are considered "secure", a factor will be more flexible than a bank.
This flexibility is also felt in the event of cash flow variations, due for example to the seasonal nature of business. A factoring company knows how to adapt to these particularities.
Commercial information
When a company enters into a commercial relationship with a new customer, it appreciates knowing the customer's financial situation in order to assess any risks associated with payment.
Since this assessment is an integral part of the factoring process, you benefit from this analysis without having to call on commercial intelligence services, so you can conduct your operations with greater peace of mind and full knowledge of the facts.
Foreign currency advance
Factoring is of real interest to exporting companies.
In concrete terms, early collection of receivables is an excellent way of avoiding the risks associated with exchange rate fluctuations.
Disadvantages of factoring
High costs
While factoring keeps your cash flow healthy, it's not a free service! In fact, the associated costs are quite high (processing fees, financing commission, guarantee fund, etc.).
For an unprofitable company, factoring may not have the desired effect - it's a calculation you have to make...
Management time
As we have seen, factoring saves time in managing receivables. But this advantage needs to be put into perspective, since factoring is a time-consuming process.
You need to set aside time in your schedule to select the invoices to be sent to the factor, inform your customers about the factoring process, etc.
Difficulty in understanding contracts
Factoring contracts are still quite complicated for beginners to understand. Factoring costs, for example, are calculated according to a number of criteria: invoice volume and average value, financial situation of the company, volume and type of customers involved, and so on.
Subscribing to factoring services also means looking at the other charges applied, in particular the application fee, the financing commission and the factoring commission. As well as adding to the cost of the contract, they also make it more complex for companies to understand, and they may choose to use a broker to clarify the various clauses.
Degradation of customer relations
By handing over the management of your accounts receivable to a factoring company, you relinquish part of the management of your customer relations.
In other words, you no longer have full control over the way in which your customers are approached, and how they comply with your own requirements. For example, a factor may use more rigid collection procedures than you do.
On the other hand, factoring may be perceived negatively by your customers, who may wonder whether you are in financial difficulty.
Not a solution for every company
Factoring is not applicable to all companies. While high rates are already an obstacle for some companies, there are other factors at play.
For a start, factoring companies often impose a commitment over several months (or even years), sometimes with the entire receivable locked in. This can be an obstacle if you want to commit to a shorter term, or maintain better control over customer relations.
In addition, financing may be limited. Foreign operations, small number of customers... depending on the situation, some companies may be turned down by factors.
FAQ on factoring
What are the different forms of factoring?
- Conventional factoring: the most widely used factoring method, it covers a wide range of services (cash flow financing, receivables management, coverage of non-payment risks). Here, the customer is notified of the company's recourse to factoring. The amount due is then paid directly to the factor.
- Confidential factoring : confidential factoring means keeping control of receivables in-house. As a result, customers are unaware that the company is working with a factor, and pay their invoices directly to the factor.
- Notified unmanaged factoring: the company manages the accounts receivable; the factoring company only provides the financing service. This means that the company retains in-house responsibility for invoice collection. On the other hand, the customer is notified of the factoring.
- Reverse factoring: the company uses the factor to pay its suppliers. It benefits from a commercial discount, and reimburses the factoring company when its invoices fall due.
How much does factoring cost?
Determining the exact cost of factoring is a complex matter, since contracts can be tailored to suit individual companies and their needs.
In fact, amounts are calculated on the basis of numerous factors, such as the volume of invoices concerned and their average value.
In addition to these factors, factoring involves a number of charges:
- processing fees, which are often variable,
- financing commission, for cash advances (bank rate + 2% to 4%),
- factoring commission, for invoice management and payment guarantee (between 0.4% and 2.5% of sales incl. VAT).
All in all, the total cost can represent up to 15% of the amount of receivables assigned to the factor.
What are the alternatives to factoring?
Ultimately, if your business is not sufficiently profitable, or if you wish to control your customer relations as effectively as possible, we advise you not to automatically consider factoring.
Why not use invoicing software, for example? These tools enable you to retain full control of your accounts receivable, by centralizing all the necessary information. This gives you real-time visibility and data on the status of your customers and the tracking of their payments. Finally, this type of solution also automates the collection procedure.
Note that credit management software also exists, enabling you to go further than an invoicing tool. While these solutions also manage unpaid invoices, they allow you to benefit from the know-how of experts on consulting missions, to analyze risks for example.
Whatever the case, factoring remains a valid solution. Now that you know what it involves, it's up to you to see what advantages you can derive from it, in the light of your company's situation and your growth objectives.
Article translated from French