Top 5 Advantages in Debt Funding for SME
Both small and medium enterprises, collectively known as SME, face a mutual problem i.e. financing. It is hard for small companies to take a loan from banks because of the many requirements put forth by the lending bank and that is where Debt Funding make sense.
Availing of loans from banks may place a huge burden of payment on the company, as it will require the company to pay interest in addition to the loaned amount.
This process cannot guarantee the growth of the company due to the presence of high dues. Some business owners find it hard to manage the finances of the business, thereby causing them to go bankrupt. When you take a loan from a bank and do not pay it back on time, you put your business at a high risk because the interest you pay will continue to increase, thus the lessening the chances of the business growing. This also lessens your options in investment due to the fact that the payment of the loan amount keeps looming over your business.
What is Factoring?
On a straightforward thought, SME’s are looking for an alternative to lessen the burden that may be encountered during debt financing. Factoring is one of the most beneficial alternatives for SME’s. When an enterprise sells its invoices to the factor (third party) in an exchange for cash, the factoring transaction or process begins.
The factor will pay 70-80 percent of the invoice value. After issuing the funds’ receipt rendered by the factoring company, the abide amount shall be paid right away. Then, the factor absorbs the discounted amount, which serves as the payment for the offered service.
Types of Factoring
There are two types of factoring -recourse factoring and non-recourse factoring.
- In recourse factoring, there is an agreement between the parties that the business must buyback receivables that the factor cannot collect.
- In a non-recourse factoring, the risk of non-payment of a customer is accepted by the factor. Due to this reason, services are usually at high rates.
The Factoring Process
A factoring process starts when the enterprise employee/owner issues a receipt to their costumer for the products bought. Then, the factoring company evaluates the customer’s credit to ensure that there is no possibility of a default. This is followed by the verification of the factoring company to the customer. The factor then collects the payment from the customer. Finally, the factor pays the SME with the remaining of the invoice amount.
The Advantages of Factoring
The top 5 advantages of Factoring include:
- A cost-effective way of outsourcing: This concept is one of the most considerable advantages, as an SME owner can save a considerable amount of time. SME owners can focus on managing the business, thereby letting them excel on their chosen enterprise.
- Factors can help you in your business: Factors are not just people who can help on the financial aspect, but they can also help in gathering information about your customer, such as their credit standings. They can also help in negotiating with your suppliers, so that you could avail a more affordable price.
- Improve cash flow: Factors can pay up to 80 percent of invoices. Thus, they can help eliminate cash flow if the business cannot be paid within 30-90 days to be paid.
- SME can avoid debts: In simple words, factoring is not loaning. Therefore, it will not add up to the debt of the company. This can help the enterprise owner save the burden of being indebted.
- Factoring can help you excel in business: Factoring companies will help an enterprise owner develop more desirable qualities in handling their business. Factors can help the owner create connections with possible business partners such as suppliers. Thus, the owner will be able to figure out the credible customers for the business.
Validity of the Factoring Company
As an SME owner, ensure that you do not forget to check the validity of the factoring company where you will seek assistance. One of the key points that one should remember is that the factoring company should already have an established and remarkable reputation in the business world. It is important to consider hiring a known company as your factor, as anything that engages with money can cause serious conflicts. A factor should be qualified enough to become a third party of the business, in order to be able to cater all the company’s needs and provide good service.
Difference Between factoring and Bank Loaning
When you are a small medium enterprise (SME) trying to start a business, the initial problem would be money or how to maintain your money. When you decide to take a loan from a bank, you will undergo a long and tiring process before receiving the money, with the additional possibility of the loan being rejected. Factoring receivables is helpful to small companies because it helps your business to grow without needing to avail of a loan.
There are Three Main Differences between Factoring and Bank Loans
- When you opt for a bank loan, the main attribute banks usually consider is the number of assets possessed by the borrowing person or company. The bank usually considers this, just in case you are incapable of paying back your loan. This collateral includes capital, inventory, equipment assets, property or any materialistic things you have that can be valuable in the long run for the bank. This becomes the key factor behind the decision regarding whether the bank loans you the money or rejects your offer. The collateral also plays a major role in how much money they are willing to loan you. However, in the factoring of receivables, the main criterion is the value of receivables and the credibility of the company that owes the receivables.
- Another way that factoring of receivables differs from a loan is that the former is simply selling a portion of your assets and not the entire asset. However, when you take a loan from the bank, you are putting your entire asset at risk when you are unable to pay the loan. You would be running the risk of losing all your belongings.
- In factoring of receivables, there can be added benefits that you could provide to the factoring company (third party) which includes providing additional services such as doing a background check or evaluation of the credibility of all customers and conducting follow ups on collections of the accounts receivables. Such offers are not applicable in case of bank loans.
What are the Risks of Factoring?
Some common risks and resulting queries include:
- Factoring Firm’s Perspective or their reputation.
- Are the invoices real?
- Do you depend on only one or two major customers?
- Are your customers credit worthy?
- What does your personal credit history look like?
From your Perspective
When your clients have an unreliable record of paying invoices, you will be paying a higher factoring fee to the factoring firm. There is a possibility of the cost of the invoice factoring fees becoming so high that it becomes a liability to your business. When a customer never pays the invoice, there is a certain penalty depending on the contract you sign. Usually, the factoring company will require that the money advanced on the invoice will be the amount to be paid and of course, the factoring fee must be paid as well.
If the amount of invoice is small, then it may not be much of a concern when compared to the larger amounts which may cause you to lose a huge amount of money, which is generally not good for business. You must always assess the invoices or the debts of your clients before you consider hiring a factoring company.
Image source:Funding Note
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