Is factoring an alternative to financing through a bank?
Factoring is a tool for professionally managing receivables.
Factoring is a management support and a financial technique, aimed at satisfying the management needs of a company's receivables.
Factoring includes several services:
- Administration, management, and collection for and of receivables;
- Legal assistance for the receivable recovery phase;
- Customer reliability assessment;
- Providing an advance on receivables before their maturity date;
- Guarantee of successful completion of operations.
Factoring is therefore not an alternative to bank financing, but it certainly does have a financial component that can be used as a complement to other sources of financing available to the company.
What companies can factoring be useful for?
Factoring is useful for any company which wants to entrust the management and control of their receivables portfolio to a specialist.
The need for factoring arises when there is an imbalance between the needs of the company's trade receivables policy (relating to anything from the payment terms and conditions to be granted to the customers who purchase their products and/or services, the funds to be committed to financially "support" the extensions granted, the forms of settlement, the control of the relationship, to the procedures for collection and recovery of the receivables) and the resources which the company can independently use.
The prospective clients are therefore made up of companies which manifest a "factoring need" connected to their management (e.g. administration, control, collection, credit insurance, etc.) and financial situation (e.g. customer evaluation and integration of traditional credit lines thanks to an advance on the receivables).
In the Italian market, factoring currently involves a wide range of product sectors and companies of all sizes.
According to a survey about the factoring demand of Italian companies, companies who are: younger, currently in a phase of strong expansion, have highly seasonal activities, and more generally, have the management of working capital as a strategic aspect of their business make more intensive use of factoring.
How widespread is factoring among companies?
Factoring is still a little known tool, even though companies often use it.
In fact, companies know little about the specific characteristics of factoring.
This is due to an insufficient financial culture, as well as an inadequate amount of information disclosed by banks and factoring companies.
Moreover, factoring has now become a consolidated tool in the economic and financial system.
It has been present in Italy for more than thirty years and tens of thousands of companies make use of it.
In general, companies which have a more consolidated experience in using factoring appreciate its advantages and specificities more and therefore make better and more methodologically convenient judgments.
Companies which know and/or use factoring to a lesser degree are often victims of common dilemmas, make poorer and possibly non-adequate judgments relating to the factoring market, and rarely take full advantage of the opportunities that it can provide.
A large part of the companies surveyed on the demand for factoring in Italy believe that it is useful to keep a some kind of relationship with the service in the future, and also consider that it is destined to develop even more within their respective sectors.
What effects does turning to factoring have on business management costs?
Factoring can allow for savings in the costs a company incurs for the management of its receivables. This is due to the outsourcing of the related evaluation, administration, and control activities.
Supporting the company with the management of its trade receivables means conducting, according to an outsourcing logic, an operation that requires high specialization.
The company is thus relieved of the related structural costs, which are taken on by the factor (e.g. factoring company or bank) with greater cost-effectiveness thanks both to the economies of scale that characterize, for example, the collection of information on the assigned debtors, and its specialist skills in the management of trade receivables.
Factoring also makes it possible to transform fixed costs associated with direct receivables management into variable costs (the factoring commission).
Certainly the possibility of successfully replacing the traditional costs of managing receivables with the costs of factoring through outsourcing their administration and control activities and entrusting them to a factor depends on the extent (through time and space) of service(s) used. This success is therefore more probable with a long-lasting and extensive use of factoring from the company's side.
How is the real cost of factoring calculated?
Factoring is a more complex service than bank credit and adds more value too. To evaluate its costs, the appropriate terms of comparison would be the average cost of financing and the internal management of trade receivables's cost.
Factoring is not directly comparable with traditional financial instruments, such as bank credit, because of the presence of its management component.
In fact, the use of Factoring involves two costs:
- The financial cost (interest), relating to the financing implicit in the payment of the receivables before their maturity. The interest rates charged by the factor are in line with market rates, taking into account the customers' characteristics and the transactions' risks;
- The administrative cost (commission), covering the management and possibly the guarantee of the receivables' completion. The commission depends on the type of services offered and its characteristics (e.g. deadlines, amounts, etc.) of the assigned receivables.
The convenience of using factoring therefore depends on comparing traditional administrative and financial charges with factoring charges.
It is also important to assess the what the newly freed cash flows will be applied to once the receivables' have been transferred.
In fact, the financial funds made in advance thanks to factoring can be used by companies to repay outstanding debts or finance the development of sales.
This "development financing" obtained through factoring underlines its advantages and peculiar characteristics. In fact, it is used more often in the market reality by both younger companies which have strong growth prospects and customers who show greater satisfaction with factoring.
What are the effects of using factoring on business management?
Factoring produces positive effects on the various areas of business activity affected by the management of trade receivables.
Factoring produces numerous effects on the business of the company affecting the areas involved in the management of trade receivables:
Factoring includes a simplifying the customer' accounts receivables, a replacing fixed costs with variable costs, and lightening the balance sheet of items concerning working capital;
- Trade policy
The use of factoring can lead to an increase in a company's turnover thanks to the possibility of transferring not yet mature receivables and therefore freeing up financial resources for the business's development;
- Financial policy
The use of factoring involves an increase in speed of circulating working capital. This is thanks to a shortening of the monetary cycle (from the purchases of raw materials to the collection of the finished products/services' sales) which reduces the financial needs of the company.
Factoring involves modifying the functions dedicated to the relationship with customers, focusing their actions with respect to production and commercial aspects.
Does the use of factoring indicate that a company is having financial or customer relationship problems?
The transfer of receivables to a factor is a normal fact of corporate life and can actually be a sign that the supplier is "operationally valid" and is on the cutting edge.
Actually, the transfer of receivables to a factor is a normal fact of corporate life and can actually be a sign that the supplier is "operationally valid" showing that it is attentive to the governance of its receivables and plans its cash flows resulting from them.
The EEC (European Economic Community) recommended that the Member States facilitate the spread of factoring among companies as a useful tool for a more effective management of receivables involved in commercial transactions.
Only those unfamiliar with factoring occasionally tend to consider it a marginal financial instrument and/or for the recovery of problematic receivables, and consequently attribute the use of factoring to the presence of financing problems and deterioration of the quality of the portfolio, associating it ultimately to a difficult situation of the company.
In reality though, only a small fraction of companies have had problems with their customers once they joined into a factoring relationship.