Factoring or invoice finance costs can be more than the traditional means of financing. However, look at a situation where you do not get any cash at all, because you don’t have the working capital to execute the many big orders you have on hand. Compared to this situation, the higher cost of factoring becomes trivial.
Factoring increases your business’ stability, strength, and profits. It gives you access to cash when you need it the most in the shortest possible time. It certainly generates more income than it costs. So why would anyone who has been turned away by banks and other traditional sources not want to attempt for factoring?
Half the problem is the tendency to view factoring discounts as interest. There is no comparison between taking a loan from the bank and repaying it with interest, and selling invoices at a discount. Let’s say a factor charges a 3% factoring discount for 30 days.
This is often annualised as interest, multiplying 3% x 12 months and arriving at 36%, which looks truly high. The funny thing is that most businesses will give their customers a 2% discount as an incentive for paying the money in 10 days. Moreover, in most cases, the customer will enjoy the 2% discount, yet not actually pay in 10 days.
Therefore, considering that the year consists of 36 x 10 days, if the ten-day discount of 2% is calculated annually, what do we get? The business has paid 2% x 30, or 72 %. Of these ten-day payments, only a few actually come in at the agreed time, even though they enjoyed the discount. Interesting, isn’t it? Yet, these businesses will not see the reason. They will tell you that they are discounting for cash.
So, one should also understand that factoring is also discounting for cash and not interest. In any case, factoring cannot compare with the 2% discount for 10-day terms. This is because factoring discounts are generally less than the terms offered by businesses to their customers. In addition, factoring advances are received by the businesses within a day or two of presenting the invoices, whereas the 10-day payments at a 2% discount will take at least ten days, if not more.
Thus, the first thing to understand clearly is that with factoring, you are taking the cash generated and using it to grow your business, earning far more than you paid for it. If, as a business, you will not earn more as a result of receiving the factoring advance, then factoring is not for you. However, if factoring can increase your profits, you simply cannot afford to ignore it, as you will end up losing money in lost business.