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. Many B2B companies decide to use factoring to solve problems linked to their customers' payment deadlines, and to obtain the finance they need to pay their various expenses and investments.
But is factoring really a miracle solution for every situation?
To help you see where you stand in relation to factoring, let's take a look at its advantages and disadvantages.
Factoring: why use it?
Factoring is a system designed to facilitate the recovery 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 specialised credit organisation (usually a bank subsidiary) known as a factor.
However, factoring is only possible in the context of a B2B activity, and therefore does not apply to invoices issued to private individuals.
How does factoring work?
There are several types of factoring (traditional factoring, confidential factoring, unmanaged notified factoring, etc.). But the core of the process remains the financing of cash flow.
Here are the various stages:
- The company sends the factor the list of customers for which it wishes to use factoring.
- The factoring company checks that they are solvent and in a favourable financial position, 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 after they have been issued. That's a long time for cash not to flow into your treasury, while your expenses (salaries, supplier payments, etc.) remain.
With factoring, you benefit from this money immediately to make up for the cash shortfall. This technique allows you to better forecast and plan your future activities.
Protection against non-payment
As we've seen, the factoring company always makes enquiries about your customers' financial health. So you don't have to do this work to determine who is likely to default on their commitments.
What's more, if the factoring contract you have taken out includes a guarantee against non-payment, you will be compensated 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
In some cases, the management of accounts receivable 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 checking payments, monitoring and reminding customers, etc. As a result, you have more time to focus on your core business.
Flexibility
Factoring offers greater flexibility than overdrafts. In fact, 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 the 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 company's process, you benefit from this analysis without having to call on commercial intelligence services, so you can carry out your operations with greater peace of mind and full knowledge of the facts.
Foreign currency advance
Factoring is of real interest to exporting companies.
More specifically, early collection of receivables is an excellent way of avoiding the risks associated with exchange rate fluctuations.
The disadvantages of factoring
High costs
Although factoring keeps your cash flow healthy, it is not a free service! In fact, the associated costs can be quite high (application fees, financing commission, guarantee fund, etc.).
For an unprofitable business, factoring may not have the desired effect. It's a calculation you have to make...
Management time
We have seen that factoring saves time in managing receivables. But this advantage needs to be put into perspective, because factoring is a fairly time-consuming process.
You have to set aside time in your schedule to select the invoices to be sent to the factor, inform your customers that factoring has been set up, and so on.
Difficulty in understanding contracts
Factoring contracts are still fairly complicated for beginners to understand. Factoring costs, for example, are calculated on the basis of a number of criteria: volume of invoices and their average value, the company's financial situation, the 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, these charges make it more difficult for companies to understand the contract, and they sometimes choose to use a broker to clarify the various clauses.
Degradation of customer relations
By handing over the management of your receivables to the factoring company, you relinquish part of the management of your customer relations.
In other words, you no longer have full control over how they 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 about your possible financial difficulties.
Not a solution for every business
Factoring is not suitable for all businesses. While the high rates are already an obstacle for some companies, there are other factors involved.
For a start, factoring companies often impose a commitment over several months (or even several years), sometimes with the entire receivable locked in. This can be an obstacle if you want to make a shorter commitment or maintain better control over your customer relationships.
In addition, financing may be limited. Operations abroad, small number of customers... depending on the situation, companies may find that their applications are turned down by factors.
FAQ on factoring
What are the different forms of factoring?
- Traditional factoring: the most widely used factoring method, it covers a wide range of services (cash flow financing, customer receivables management, cover against the risk of non-payment). Here, the customer is notified of the company's use of factoring. The amount due is then paid directly to the factor.
- Confidential factoring : confidential factoring involves keeping control of customer receivables in-house. As a result, customers are unaware that the company is working with a factoring company, and pay their invoices directly to the factor.
- Notified unmanaged factoring: the company manages the receivables; the factoring company only provides the financing service. The company therefore retains responsibility for collecting invoices internally. However, the customer is notified that factoring has been used.
- Reverse factoring: the company uses the factor to pay its suppliers. The company 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 complex, since contracts can be tailored to suit individual companies and their needs.
The amounts are calculated on the basis of a number of factors, such as the volume of invoices concerned and their average value.
In addition to these factors, there are a number of other charges that apply to factoring:
- administration fees, which are often variable
- the financing commission, for the advance of funds (bank rate + 2% to 4%),
- the factoring commission, for invoice management and payment guarantees (between 0.4% and 2.5% of turnover including VAT).
All in all, the total cost can represent up to 15% of the amount of receivables transferred to the factor.
What are the alternatives to factoring?
Ultimately, if your business is not sufficiently profitable, or if you want to control your customer relations as much as possible, we advise you not to automatically consider factoring.
Why not use invoicing software, for example? These tools allow you to keep full control of your receivables by centralising all the necessary information. This gives you visibility and real-time data on your customers' situation and the monitoring of their payments. Finally, this type of solution also automates the collection procedure.
Note that there is also credit management software, which allows you to go further than an invoicing tool. While these solutions also manage unpaid debts, they allow you to benefit from the know-how of experts as part of consulting missions, to analyse 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