Factoring is a process where a factoring company buys the cash receivables of a business and advances them some cash. This often helps in sorting out problems of cash flows. The cash advanced is based on the unpaid bills that the factoring company will then collect in order to recover their money. This is a common practice where immediate cash is needed in order for normal business operations to proceed. This helps in maintaining the cash flows.
The factoring companies offer a lot of benefits to the people who use them. The first is saving on time. It would take a lot of time for the business to collect from the people who owe them. This would also disrupt business. The company thus takes this need away. It also provides the business with an avenue for growth as normal business operations can proceeds which means that the business will not stagnate. They are also convenient as they do not require collateral for the business to qualify. This is also a good avenue to get more funding as they advance more than one would get from banks. They are also faster and more flexible than bank loans.
On the other hand, the factoring companies may be disadvantageous for the business.
The stigma – Your customers will get a notification that their invoice will be paid to the factoring company and not the business. This thus alerts them of your cash flow problems. Some businesses may take this as a negative sign and become cautious about dealing with your business. It is thus best to ensure that invoice factoring is not used all the time.
The costs incurred – as the cash is advanced immediately, it may eventually come at a higher cost to you. Most will charge an interest rate on the cash that was advanced. It could e about2%. This does not include the 1 to 4% that they keep from the cash receivables as part of their fee. In the end, the annual interest one pays may add up to 30%.
Less control – Giving up your cash receivables to the factoring companies means that you give up some control. In case one of the customers has a bad credit rating they may request that you stop doing business with them or even define how you conduct business with them. They will have a measure of control as they need to ensure that they get their money back.