A transaction in which selling of accounts receivable is done at a discount is called debt factoring. The company that purchases the account receivables is called a factor. After the completion of the transaction, factor starts collecting amounts from the business customers. The business receives cash from factor immediately after the transaction is complete. Debt factoring has disadvantages too. Business sells the accounts receivables at a discount while other means to finance the business may available at the lower costs.
Pros and Cons of Debt Factoring Arrangements
The debt factoring arrangement is done by a business to improve the cash inflow. Without the process of collection, the business receives immediate cash. A number of pros and cons should be considered before entering into the debt factoring transaction. The basic benefit of debt factoring is that you are provided with a quick method of financing. The cash is directly taken after the transaction completes. Factoring is very important if the business needs cash for financial growth. Potential benefit of factoring is the protection from bad debt. A non-recourse agreement is very beneficial for the protection from bad debts. The factor assumes the risk of bad debt under this agreement. It means that the factor will absorb the loss if customer account cannot be collected.
Another potential benefit of debt factoring is cost effective collection of accounts receivable. When a business sells its accounts receivable, it completely hands over the accounts receivable collection process. The business pays the cost, for the transaction, in the form of discount amount. It may cost high to the business but it is very beneficial for the companies that want save time as well as reduce the employees to do the task.
A business also should consider a number of disadvantages before entering the debt factoring agreement. The cost in the form of discount is the primary disadvantage. A factoring agreement can be very costly, depending on the discount amount. There are some other methods to finance the business than debt factoring, so that should be considered before making agreement. The other disadvantage is the interference in the business in the form of factor. As the factor will collect the accounts receivable, there is high probability that they will influence the customers and the sales practices consequently. They can influence the timings and policies of sales.
Another big advantage is debt liabilities that are applicable in the case of entrance of business into a resource factoring agreement. The business is responsible, in this case, for the entire amount that are not paid by the customers. The discount rate under this agreement is lower usually but the possibility of uncollectable charges should also be considered. Another potential disadvantage is in the form of customer relations. Now the third party will directly collect the amount from the customers, there is a possibility that the customers develop a negative impact of the business. The problem may be severe if the factor is dealing aggressively with clients or they don't have any professional practices for collecting receivables. Debt factoring is a complex business agreement in fact, in which a long term contract and modification of a few sales process is required. So, its advantages and disadvantages should be considered before going into an agreement.