Factoring as an Alternative to Debt Collection: Pros and Cons
With factoring you get paid for your invoices straight away instead of waiting for the customer. But what does it cost, who bears the risk, and when is it a better choice than debt collection?
What is factoring?
With factoring you assign your invoices to a factoring company, often a bank or a specialist finance company, and receive most of the invoice amount straight away. When the customer pays, you receive the rest, less the factoring company's fees and interest. The customer is told to pay the factoring company instead of you.
Factoring is therefore first and foremost a financing tool: you free up cash that would otherwise be tied up in unpaid invoices.
Factoring and debt collection: two different tools
Factoring and debt collection are often mentioned in the same breath, but they solve different problems:
- Factoring is used before there is a problem: to get money quickly for invoices that are expected to be paid.
- Debt collection is used when there is a problem: to recover an overdue claim the customer is not paying.
Many factoring companies do, however, include follow-up on overdue invoices, so you do not have to chase payments yourself.
With or without recourse
The most important difference between factoring agreements is who bears the risk if the customer does not pay:
- Recourse factoring: if the customer does not pay, the factoring company can claim the money back from you. You bear the risk of loss yourself. This is typically the cheapest form.
- Non-recourse factoring: the factoring company takes over the risk of the customer being unable to pay, for example on bankruptcy. It is more expensive, and the company will typically credit check your customers and set limits on how much it will take on.
Expert tip: Read what "non-recourse" covers
Non-recourse factoring often only covers the customer being unable to pay, for example on bankruptcy. If the customer disputes the invoice because the goods were defective, the risk typically still lies with you. Read the terms carefully.
What does factoring cost?
The price typically consists of:
- A fee per invoice or a percentage of the invoice amount
- Interest on the amount paid out until the customer pays
- Possibly a set-up fee or a minimum charge
Prices vary considerably by provider, your customers' creditworthiness, invoice volume and whether it is recourse or non-recourse factoring. So compare several offers, and work out the total annual cost, not just the fee per invoice.
Pros
- Fast liquidity: you do not wait 30 days or more for payment
- The financing grows with your turnover
- Less administration chasing debtors
- Non-recourse: protection against losses if the customer becomes insolvent
Cons
- It costs money, often more than an ordinary overdraft facility
- Customers are told the invoice has been assigned, which some customers notice
- You give up some control over contact with your customers
- Lock-in periods and minimum volumes can make the agreement inflexible
Expert tip: Ask how your customers will be contacted
The factoring company will communicate with your customers about payment. Ask how reminders are worded and when a case is passed on to debt collection. This matters for your customer relationships.
When is factoring a good choice?
- You are growing fast and cash cannot keep up
- Your customers are solid but have long payment terms
- You have seasonal swings and need cash in certain periods
- You want to stop chasing invoices yourself
Factoring is not, however, a solution for invoices that are already disputed or long overdue: there, debt collection or legal action is typically the way forward.
Getting started
Consider factoring if your problem is waiting time and liquidity, and debt collection if your problem is customers who do not pay. If you have overdue claims, you can use InkassoHurtig to get no-obligation quotes from police-authorised debt collection agencies and lawyers. This content is general information and not legal advice.