Factoring:<br>Advantages and Disadvantages of Factoring

Advantages of Factoring

Factoring has become popular all over the world thanks to the services it offers. Factors provide services that range from financing to the administration of sales on credit: financing, keeping accounts, collecting accounts receivable, and protection against credit risks. The services which will be provided are stated in the factoring contract - a contract like any other contract of sale, regulated under the law of contract.

Some advantages of factoring include:

• No time wasted on comprehensive loan applications
• Better cash flow and quicker access to working capital
• Better liquidity through on-time cash injections (advances from the factor)
• Better financial standing, creditworthiness, and solvency
• Higher sales volume - the company can offer its customers better credit terms and can accept more business
• Better terms for new customers (important for exporting companies)
• Risk or bad debts eliminated, under non-recourse factoring, or at least reduced through timely collection
• Business growth funded without new debt - no monthly payments or balloon payments
• No sale of equity (no new shareholders to raise funds)
• No personal guarantees, unlike most loan programs;
• No material insurance
• A stronger balance sheet, enhancing borrowing potential, as factoring is off-balance sheet and does not need to be reported to prospective lending institutions, boosting the efficiency ratios (e.g. return on assets etc.)
• Easier to finance seasonal production
• ‘Fresh' working capital means suppliers can be paid in advance, at an additional discount
• Less time and effort needed to collect receivables, because the factor is specialized
• Operating expenses reduced (for the reasons listed above)
• Even a start-up or young company can obtain financing quickly
• Better information management (especially under full factoring)
• Allows quicker, smaller, ‘just-in-time' purchases

Disadvantages of Factoring

It should be emphasized that besides the evident advantages, factoring also has disadvantages, such as:

• Over-reliance on a factoring company can result in excessive trading and mismanagement.
• Over-reliance on a factoring company can also result in loss of direct customer relations.
• Some types of company are not attractive for factoring, such as:
  • Small low-volume companies
  • Companies whose accounts receivable originate from only a few customers
  • Companies with many small customers
  • Companies with speculative business
  • Companies with a wide range of products sold to the general public
• Factoring costs are normally higher than those of bank loans, so the price of the final product will be higher as well.
• Exporters must insure there are no disagreements with buyers over product quality.
• Some buyers do not like parties other than the seller to be involved. 
• Factoring is short-term financing and cannot meet all business needs.
• Factoring occurs only when the factor is quite sure of the client's solvency.
• Factoring companies prefer customers with larger businesses.
• Only non-recourse factoring releases the client from collection risk. In all other cases, the client remains responsible for default (even for discounted receivables).
• The client can suffer substantial revenue loss, given all the commissions and the risk of loss involved.