The current economic climate is still on the road to recovery. During this time, small to medium sized businesses need to be smart with their cash flow and capital management. The reason for the delay of the financial recovery is that the lending behaviours of banks has changed in the last few years.
Businesses, normally, are at the mercy of their debtor’s payment schedules. This holds true when invoices are raised in arrears. While depending on the schedule, there can be an indefinite waiting time period, averaging 1 to 3 months. At the same time, a business needs cash to manage its overhead costs and wages. This is where factoring comes in, helping to bridge the gap.
Factoring and cash flow – how it works
There are numerous agents that can increase the cash flow gap in a business. For example, an increase in the number of transactions can cause complicated scheduling for managing incoming and outgoing capital. For thriving businesses, instant cash is an asset of necessity.
Factoring is the solution. It is basically a form of lending where money is provided against the value of a certain aspect, such as invoices.
Types of factoring services
The most common type of factoring is the invoice factoring. In a basic scheme, a factoring service would transfer nearly 90% of the invoices to a business account, which helps in overcoming the scheduling conflict.
Some capital management services and invoice factoring services have further classified invoice factoring into different types. As per Crestmark, the types are:
1. Discount or Recourse Factoring
2. Traditional or Non-Recourse Factoring
Discount factoring is a form of flexible and immediate lending. In this case, there is the advantage of getting supplier discounts through either volume purchases or early payments. This form of factoring has the advantage of being less expensive and less restrictive.
Traditional factoring mostly revolves around outsourced credit and collection services. It has the advantage in the sense that it provides protection against credit risk of account debtor. On the cost front, it is more expensive than discount and is slightly restrictive in terms and conditions.
In both cases, the underlying premise is the same: swift access of cash and bridging the capital flow gap.
Factoring and bank lending
There are some differences between taking a bank loan and using factoring services. In the case of loan, there are set interest rate and arrangement fees. Factoring is a cash saving option and has moderate fees that are divided into a service fee and interest. Both of these are flexible and largely dependent on the amount of invoices.
For instance, the service fee is mostly related to the daily servicing of your business purchase ledger. The fee is dependent on your turnover. The interest amount is mostly a fixed rate and is charged against the amount of an individual invoice.
The fractured pricing strategy and invoice dependent interest rate makes factoring a better choice over bank lending.
The analysis provided above clearly provides a solution to bridge the cash flow gap. In current business atmosphere, such options are not only necessary, but also important in gaining a competitive edge. Businesses in which the principle asset is cash should opt for such measures for better capital management.