When Factoring Fits

It's not uncommon for a company to turn to factoring for one reason or another. Many times it is all about cash flow.

They need money and they have invoices. Pretty simple. They can turn those invoices over to the factor and get the money now, essentially selling them. They have the money they need, when they need it and they have no new debts to speak of. The factor then handles the collection of the funds from the debtor. This works in specific cases and for various reasons.

Cash flow is always a wildly popular topic, but with new finance challenges and high interest rates, it makes sense that more companies are exploring this option. There are a lot of scenarios when this might be a reasonable consideration, but there are risks that can go along with the benefits of factoring, so it is important to know everything involved.

If you are turning to factoring to access cash, then there are some considerations.

The most common type of factoring is recourse factoring. While this the less expensive option, the company that sells the invoices is still on the hook in the event that the invoices are not paid. They are carrying all the risk. This type of factoring is a means of cash access and outsourcing of process that is less expensive and does not involve the same degree of customer vetting by the factor. You might look at it like a cash advance or payday loan for businesses. If a company is recourse factoring and the invoice isn't paid, they will have to pay the factor back. If they are leaning on the factor for the majority of their AR process, they need to explore some additional tools to protect themselves from a loss.

If a company already has stable customers, this may be a reasonable option. If cost is the bigger concern with some specific cash flow needs, a combination of recourse factoring and a trade credit insurance policy may make more sense.

Sometimes a company will turn to factoring wanting to mitigate risk and improve their cash flow. Maybe they are in an industry that often has extended terms or higher risk. Maybe they have some seasonal fluctuations that impact these considerations, or they just want to stay removed from the credit risk management and collection side of business. Non-recourse factoring is going to be more expensive, but it will provide a shield and prevent a company from having to deepen focus on credit and collections. It may make sense in the event of a particularly risky customer, an industry with sporadic fluctuations or in a strained economy.

It's important to consider all the options available before making a choice about factoring because one of the most important things to understand about factoring is that it is very difficult to stop once you have started. It may make sense to consider the options available and explore some methods that might be more cost effective like combining an ABL with trade credit insurance as a lower cost alternative that offers more flexibility in an exit or maintaining of control.