Entrepreneurs running small and medium companies often wonder what form of raising financial capital to choose: bank loan or factoring for small companies ? Both alternatives seem to be similar, but they contain a lot of significant differences. What’s more, not every company can afford to take a loan from a bank . This is related to the assessment of the company’s financial condition and creditworthiness. Meanwhile, factoring is much more available and does not require as much collateral as a revolving loan . Factoring as well as credit for small companies are a source of financial capital that enables financial liquidity and meeting obligations.
What is factoring?
Factoring is the sale of invoices , i.e. the purchase by a company that provides financing (for example, a bank or financial institution) of receivables and invoices having a deferred deadline issued by the entrepreneur to its recipients for products and services sold. Therefore, the factor buys the company (factor) invoices, transferring 80-100% of their value to him . The rest is the commission for the risk taken and the services rendered to the factor. The entrepreneur can use the money received for invoices to regulate his obligations arising from running a business on an ongoing basis or to invest and develop the company. Thanks to this, it gains financial liquidity , and timely payments to suppliers often allow the use of various rebates, increase its credibility and improve the company’s image. Factoring for small businesses is also recommended if the company has a problem with disciplining its recipients who are notoriously late in making payments. The accumulation of such situations definitely makes it difficult for the entrepreneur to meet his own financial obligations. Therefore, factoring creates a more predictable business model.
How is factoring different from working capital loan?
Purpose of use
A bank loan is taken for a specific purpose accepted by the bank. It cannot be used otherwise than in the manner indicated on the contract with the bank. Meanwhile, the company can use the funds resulting from factoring in accordance with its own current needs. There is no need to reconcile this with the factor, it is the entrepreneur who decides what the financial capital will be used for.
Company profile and security
To get a working capital loan, a company must meet many conditions that play an important role in assessing the company’s financial condition. Banks are interested in the company’s credit history , its period of existence and market position. In connection with the above, the loan can be afforded by companies with several years of activity, which have numerous collateral, such as, for example, promissory note, sureties, pledge, mortgage or assignment of receivables. Meanwhile, factoring is dedicated to young entrepreneurs operating on the market for at least a year. It is much more accessible and does not require an established position of the company or good financial condition. Therefore, it can be used by small and medium-sized enterprises currently in the process of dynamic development, having reliable and proven recipients of their products or services that want to maintain financial liquidity. The security is issued by the customer invoices , blank promissory notes and power of attorney to the company’s bank account.
Concluding a factoring contract is very simple and convenient. The simplified procedure certainly attracts young entrepreneurs who are not financially sound but have proven recipients of their services.
Risk of insolvency of contractors
In the case of credit, the risk that recipients will not pay is borne by the entrepreneur. He is responsible for collecting money for the products he sells and services rendered. Meanwhile, factoring for small businesses looks completely different. By purchasing invoices, the factor assumes the risk related to the insolvency of the contractors of a given entrepreneur (in the case of non-recourse factoring – full factoring ). He returns to the factorer, i.e. the entrepreneur, to whom he provides financing from 80 to 100% of the value of invoices issued by him. The rest is the commission, i.e. payment to the factor for the services he provides and the risk taken. The factor’s duty is to control the accounts of the entrepreneur with his recipients and keep accounts. So, in fact, it is the factor that awaits the payment of invoices and deals with collecting debts. When the recipients do not make payments, the factor’s employee contacts them and sets the payment date and sends a payment request. Meanwhile, the entrepreneur regularly receives funds from the factor constituting 80-100% of the gross value of his invoices. So he doesn’t have to worry about late payments, through which he collapses his obligations, because he receives invoice financing on an ongoing basis. The problem of delays in payment for products purchased from the entrepreneur and services rendered, as well as all compensation and debt collection procedures is borne by the factor whose task is to collect debts.
The disadvantage of factoring are its high costs . The factoring service is slightly more expensive than the obligation related to taking out a loan. In addition to the commission for the risk taken, which is a certain percentage of the gross value of each invoice, interest on capital is also charged. A preparation fee, debtors’ analysis fee or legal service may also be charged. In the case of credit, we repay borrowed money plus interest every month.