Pros and cons of receivables factoring
Thursday, 10 January 2019
Businesses looking for a more efficient means of managing accounts receivable should consider taking a longer look at the “factoring" side of the receivables equation.
In short, receivables factoring can help your business maximize and stabilize cash flow, have faster access to incoming funds, improve profits and allow you to focus more time on core strengths.
By definition, accounts receivables factoring, also known as invoice factoring, steers the customer payables invoices and accounts to a financial institution, which in turn provides the business with an immediate line of credit.
In an invoice factoring scenario, the unpaid invoice becomes a de facto form of collateral to the bank or financial institution. That saves a business from having to wait for payment, while the bank charges a service fee for handling the customer invoice payment.
With any potential change in a company's accounts receivable practices, there are upsides and downsides in shifting to an invoice factoring partnership. Here are some accounts receivable financing pros and cons:
Pros of invoice factoring
- Improved cash flow. There's no question that getting paid more quickly is a big priority for companies, and accounts receivable financing is a great way for businesses to gain fast access to cash using invoices as collateral. By speeding up the payment process, businesses become more liquid and flexible, with faster (and more reliable) access to cash. That allows companies to pay down debts, buy equipment, hire workers, and generally improve their business outlook and productivity using invoice factoring.
- Freedom from chasing down invoices. Ask any entrepreneur or business owner what's the least favorite task on their regular “to do" list and chasing down customer payments will come up quickly. That problem largely goes away with accounts receivable factoring as the bank or other lender takes on the task of handling unpaid invoices.
- Retaining total control of your business. Unlike conventional business financing options, where a percentage of your business might be used for collateral, accounts receivable factoring only uses unpaid client invoices as financing collateral. That enables business owners to keep total control over the ownership of their companies.
Cons of invoice factoring
- Service fees. Typically, accounts receivables factoring fees are higher than the fees charged for conventional business loans (fees of up to 4 percent of the invoice amount to be collected are not uncommon.) Never go into an invoice factoring scenario until you're crystal clear on the costs you'll be paying for the service.
- Your customers have to pay up – or else. In many invoice factoring contracts, language is included that holds the business responsible for any unpaid invoices. In this scenario, you'll likely still pay bank or financial institution service fees, while still having to chase down the slow- or no-paying client.
- It may confuse or concern your top clients. Good customers are creatures of habit – and they don't always like surprises or changes to their business relationship with your company. Under a factoring agreement, the financing institution may contact your customers and present themselves as the manager of your company's invoices. The financial institution also may be the one following up and asking for payment if the customer is slow in paying or who has mistakenly sent payment directly to your business. A polite “heads up" call or email to your client should mitigate that concern.
A win-win scenario
Fortunately, most of the negatives associated with accounts receivable factoring can be curbed or eliminated altogether through smart negotiations, good preparation, and candid communication with customers about invoice payments.
The positives may outweigh the negatives especially if your company is looking for a way to secure faster payments, retained control of your business, and more time to focus on the issues your company needs handled most.
The content provided is for informational purposes only. Neither BBVA USA, nor any of its affiliates, is providing legal, tax, or investment advice. You should consult your legal, tax, or financial advisor about your personal situation. Opinions expressed are those of the author(s) and do not necessarily represent the opinions of BBVA USA or any of its affiliates. All accounts and credit are subject to approval, including credit approval. BBVA and BBVA Compass are trade names of BBVA USA, a member of the BBVA Group. BBVA USA is a Member FDIC.
You may also be interested in:
How to mitigate treasury management risk
Treasury management is a high-risk environment. Here's how to mitigate the risks through internal controls and an integrated treasury management system
What Is lockbox banking?
Learn how lockbox banking services can simplify the deposit process.