When a business is running low on liquid capital to draw from, they often turn to a variety of methods in order to find a remedy. One such method is debt factoring, a valuable approach to solving any business’ cash flow woes. Debt factoring, often referred to as invoice financing, is one of the many capital-raising tools available to businesses, one especially geared toward the short-term. In this article, we will be discussing debt factoring as a potential solution for raising capital, its pros and cons, and how it might help you and your business. Let’s get started.
What is debt factoring?
Debt factoring is a method of raising capital over a very short space of time. The process involves three parties, though is pleasantly simple at its core. A business requires capital, for expansion, salaries, or any other payments. However, the business has insufficient cash on-hand, with most of its cash flow tied up in invoices. While invoices tend to be paid before the 30-day legal term, anything approaching 30 days can be disastrous for a business with a tight cash flow.
In order to make ends meet, the business contacts a company that specialises in debt factoring. This company will purchase the invoice or invoices, supplying the business with 90% of the invoice’s value upfront, with much of the remainder being paid at a later date. A percentage, usually around 3% of the invoice’s value, is taken by the company as a fee. The company will then receive the invoice payment, while the business in question walks away with the on-hand cash it needs.
Advantages of debt factoring
Debt factoring has some notable advantages. First, and most importantly, debt factoring massively relieves the stress on your cash flow, providing you with a reserve of capital that can be used as you like. Rather than waiting for invoice payments, with some payments taking frustratingly long, debt factoring can put that cash immediately in your hands, taking the pressure off your business and off your shoulders.
Time and stress saving is another advantage to debt factoring. By using debt factoring, you save yourself the trouble of chasing your customers that aren’t exactly prompt with their payments. It saves you time, which can naturally be put to more productive use, and the worries of how to phrase your payment requests diplomatically. With less stress and more time, your job of managing your business can be made so much easier.
Disadvantages of debt factoring
Nothing is free of disadvantages, with debt factoring having its own for you to consider. Of course, as you are using the services of a third party, you’ll be paying fees. This means you’ll be taking less profits, as a part of the value of your invoices will be going to the debt factoring company. While this fee tends to be only a small percentage, this can very well mean the difference between a profit and a loss for a small business.
The relationship between your business and your customers is at risk, which is the other major disadvantage of debt factoring. It’s worth stressing that this is only a risk, not a guarantee, as you will be using the services of another professional, but it doesn’t change the fact that your control over customer interaction is diminished. Once you pass on your invoices to the debt factoring company, they will also take over customer interaction as they begin to collect payments. If the company is rude or otherwise offends your customers, this likely will reflect poorly on your business.
How you can start using debt factoring
Debt factoring is of particular use to businesses that are sitting on a pile of unpaid invoices. Condemning a chunk of much-needed capital to swirl in a pending inflow. If you find yourself in this situation, it might be time to turn to debt factoring.
Applying for debt factoring, and therefore taking advantage of what it has to offer, is thankfully quite easy. The usual criteria that determine eligibility for other forms of capital raising, such as credit rating, collateral asset value, and so on are not nearly as important for debt factoring. Instead, once you hand over your invoices, the company will examine your clients’ payment history, assessing the risk of clients paying late or refusing to pay at all. If they determine the risk is acceptable, you will receive your money and they will take over client interactions.
There is one caveat to this process, however. Although the overall process is simple, some debt factoring companies may refuse to work with you if your turnover is low. Exactly what this threshold is will vary from company to company. Therefore it might be worth mentioning early in your correspondence. Once you’ve crossed that bridge and the company assesses your client’s risk factor, you’ll be good to go.
Is debt factoring right for you?
Now for the big question. On paper, debt factoring can help any business that requires imminently available cash. However, it might not be the panacea for your issues. Especially so if you’re treading a fine line between profit and loss.
Let’s start with instances where debt factoring might fit your situation. If your business is operating healthily and with a comfortable profit margin, with the only main issue being the availability of said profits, debt factoring can certainly be of assistance. It can help you seize an opportunity to expand your operations. Fund equipment purchases or urgent maintenance, or simply pay your employees.
Debt factoring isn’t always the solution though. As we’ve mentioned before, businesses operating with particularly tight margins may find this method an unpalatable risk. As the associated fees will effectively be taking a portion of your earnings straight out of your pocket. If you find yourself in this situation, you might be better off looking at other forms of finance. Bridging loans being one such example. No matter your situation, it’s always a good idea to seek advice from a professional before going ahead with any decisions.