Debt factoring is when a business sells off its trade receivables to a third party in return for an immediate cash payment of a portion of the debt. Factoring services are often used when a business organisation is facing cash flow issues and needs an immediate sum of cash to settle their debts or to ensure business continuity. The factoring agency takes responsibility for the collection of debts from the actual debtors of the company. The risk of non-settlement may or may not be transferred to the factoring agency depending on the type of factoring arrangement. Debt factoring without recourse transfers the risk of irrecoverable debts to the factoring agency where they will have to pay the client organisation the full amount even if they were unable to recover all the debts. Debt factoring with recourse is simply an advance payment arrangement where the factoring agency charges the client organisation for any debt it is unable to recover. Although debt factoring agencies share similarities with organisations such as debt collection agency Queensland, there are several key differences including the fact that debt collection agencies merely collect the debt for the organisation in return for a fee whereas factoring organisations “buy” the debt and immediately pay the client organisation.

Advantages of Debt Factoring

Debt factoring gives quick access to cash using an organisation’s receivable balance before their customers have settled their debts with the company, allowing the organisation to use the cash in reinvesting activities or to exploit any business opportunities that might avail themselves to the business.

Debt factoring allows organisations with cash flow and liquidity issues to continue business activities without relying on overdraft and other short term financing methods which may be more expensive than simply tapping into existing finance. It can also mitigate the effects of overtrading if the receivables balance has become too large to manage; although the necessity of a factoring solution is often indicative of issues in the business function which should be rectified going forward.

Disadvantages of Debt Factoring

Debt factoring agencies charge a fee in return for their services. The money received by the factoring agency would be the trade receivable balance less this fee, which means that the organisation will essentially bear an expense in order to encash their trade receivables. The fee is higher when factoring without recourse, but the risk transfer may be worth it. On the other hand, factoring with recourse may be cheaper but the risk of non-settlement remains with the client organisation.

Debt factoring may be used as a remedy for internal problems in the business, specifically in finance and credit control departments, that may go ignored due to the solution presented by the factoring agency.

Association with the debt factoring agency may be harmful to the business image and may signal the investors that the organisation is facing cash flow issues, presumably due to issues in the credit control department of the organisation, which may cause them to perceive the organisation as a riskier investment.