Factoring: More than just a financing instrument

by David Jones

Two weeks ago, object financing in general and factoring in particular were discussed in blog 19. Factoring is debt financing. It is a financing instrument that can be used specifically by entrepreneurs, both for bridging short-term liquidity shortages and for the structural financing of working capital. Factoring is therefore one of the options for directing the liquidity of a company.

Conditions for requesting factoring

Conditions for requesting factoring

Financing on the basis of factoring distinguishes itself essentially from other forms of financing. For the other forms of financing, the financial position and profitability of the credit applicant are the most important assessment criteria. This is different for factoring, where the quality of the debtors – that is, the quality of the customers of the credit applicant – is an important assessment criterion. In extreme terms, one can say that a bad company with good debtors can be financed with factoring. This statement has been the source of the misconception that factoring is the lender of last resort . In modern business, more importance is attached to focus. Modern entrepreneurs focus strongly on their core business. It is precisely for successful and financially strong companies that outsourcing debt management can help.

The traditional factoring of the entire debtor portfolio on the basis of a fixed contract term with a duration of one or two years is aimed at companies with turnover from a few million euros. In recent years, the arrival of many new factor companies has brought about a major change. ‘New’ factor companies have fewer restrictions and therefore also other target groups. They focus on large and small companies. Self-employed people can also go there. The philosophy of the new generation of factoring companies is even more emphatic: it is about the invoice to be advanced. If an invoice is prepayable, new companies are prepared for factoring. If you conclude an agreement with such a factoring company, you yourself determine which invoices from pre-selected debtors you send or not to advance. If the factoring company receives the invoice, it will be assessed within 24 hours and paid immediately upon approval.

Finding the right factor company is not that easy, because the offer is large. Those who do not know this market, are advised to orientate themselves before making a choice. It is worth considering asking the vision of an independent financing advisor.

The advantages and disadvantages of factoring

money credit loan

An important aspect of factoring is: liquidity. A company already has the money quickly after sending the invoices. This is interesting for growth companies, because rapid growth is accompanied by growing investments in stock and activities. Subsequently, the debtor portfolio also grows in such a situation. As a result, growth companies run the risk of liquidity shortage, or even of liquidity stress. Factoring means that the liquidity flow keeps pace with the growth of the company. A particular advantage of American factoring is that when assessing the financing application, the factoring company does not rely primarily on the creditworthiness of the seller of the invoice (creditor), but on that of the debtor (customer) of the company. A company with only one or a few clients is not easily financed by a bank because of the too high (concentration) risk. A factor company usually has no problem with this, provided that a completed performance has been delivered and other conditions have been met.

Finally, factoring offers the possibility of more services than just financing. The entire accounts receivable management can be outsourced to a factoring company, so that the company can fully focus on its own core business. An additional advantage is that the commercial and personal relationship between the entrepreneur and his customers is not influenced by the fact that they have to manage the debtors themselves. A source of concern and irritation is outsourced to a professional, specialized party.

Factoring a normal financing method

In fact, it fits well in the present time, where entrepreneurs concentrate on their core business. Fortunately, the old image that a company that uses factoring is ‘not just financeable’ would have been diluted. Factoring is suitable for professional companies and professionals who want to conduct good quality debtor management. Another frequently heard disadvantage has its origin in the image: factoring would be expensive. That’s right if you compare the costs of factoring against only the costs of financing at, for example, a bank. Because factoring offers more, that comparison does not hold. It is up to the entrepreneur to assess the value of the quick availability of the money, and of the outsourced operation and management. Outsourcing debtor management can be attractive for small and medium-sized companies. A point for attention is the duration of the contract. With traditional factoring, which cannot be ended prematurely, you can be bound for one or two years.

Because the factoring company looks critically at the customers’ debtors, you are encouraged as an entrepreneur to consciously choose who you do business with. After all, a ‘bad’ customer can be detrimental to your business financing.

Finalizing

Finalizing

All in all, factoring is a long-standing, now well-developed form of non-bank financing for B2B companies. It is a financing instrument that can be used by entrepreneurs in a targeted manner, both for bridging short-term liquidity shortages, for structural working capital financing and for professionalizing and outsourcing debtor management.