Factoring – the pitfalls
Whilst arguments for factoring are strong, there are also counter-arguments that need to be carefully considered. In some cases these can be overcome by the choice of factoring company but it is wise to be aware of all the facts before entering into a relationship with a new factoring company.
The following represent some of the most frequently heard comments:
“The level of prepayments are not as promised”
Most factoring companies will headline their offer of a service with a promised level of prepayment against debtors – typically this can be anywhere between 70% and 85% or even 90%. In practice the offered level is rarely achieved. This can be due to one of a number of reasons including:
- An over-riding exposure limit on the borrower or individual debtor,
- Exclusion of export debtors,
- Delays in providing proof of delivery,
- Contra amounts on the purchase ledger
- A dispute on an individual invoice that leads to the whole account being excluded.
- Debtors outside the recourse period not being disclosed
Comment
Efficient company systems can overcome some of the problems associated with under funding of debtors. Note that the headline prepayment level offered by the Factor is not always as important as the willingness in practice to fund to that level. Careful questioning of the factoring company before you take up an offer can assess this more accurately.
The majority of factoring companies will carry out an exhaustive due diligence survey before taking on a new client and this will determine the level of prepayments offered and should also be used by the client to assess whether the prospects of achieving the offered level of prepayments are realistic.
“The factoring company is not as efficient as me at collecting debts”
Comment
It is true that not all factoring companies are equal in this respect although statistics are not conclusive.
Anecdotally the smaller more flexible companies can be more efficient when dealing with smaller debtors. Certainly the smaller independent companies have a stronger motivation to be more efficient in view of their dependence on the service income to make a profit and not the margin on borrowing when they themselves have to borrow funds to on-lend from the clearing banks
“It is difficult to exit a relationship with a factoring company”
Comment
Certainly a business factoring its debts will find it difficult to replace the factoring company once it becomes dependent on the level of funding. This will be even more of an issue if further growth is envisaged.
On the other hand a well managed and profitable company with static or moderately growing sales with be able to reduce gradually its dependence on factoring before replacing a modest level of debt with a fluctuating overdraft.
Factoring contracts normally stipulate a minimum term and will be subject to a notice period – often three months. The notice period may be negotiable, as factoring companies will rarely wish to hold on to a dissatisfied client.
“Factoring is expensive”
Comment
See comments under the heading “the cost of factoring”. Remember also to compare apples with apples and not oranges. Factoring can be more expensive than a simple overdraft but is conversely far cheaper than equity. What price an expanding and profitable business?
“Factoring provides cash when you are expanding but the takes it away when you contract”
Comment
There is certainly truth in this criticism that may also affect businesses with a seasonal peak in sales. Such businesses will need to plan cash carefully in order to ensure that funding gaps do not occur. However, factoring companies understand this potential problem area and there are some who will abandon normal criteria if they can understand your business and see that the cash flow shortfall will be temporary and that a return to an acceptable position can be expected.
“I will lose control of the sales ledger and lose contact with my customers”
Comment
Once again, there is some truth in this criticism. However, success in any form of business is about communication and most of the better factoring companies will allow dialogue between client and debtor. This is best agreed at an early stage so as to avoid the factor upsetting good customers through a heavy-handed approach.
Most factoring companies these days will allow or even encourage a dialogue and / or assistance with debt collection.