What Is Factoring and What Are Its Limitations?

When it comes to alternative financing methods like microcredit, revenue-based financing, and discounting, one option stands out: factoring. Discover why countless companies flock to this game-changing solution. Delve into factoring as we unravel its definition. We explore available options, and provide an intricate breakdown of how this contract between a factor and a B2B professional operates.

We’ll also uncover its limitations and drawbacks, while presenting you with a more agile and adaptable alternative: embedded invoice financing.

1 – What Is Invoice Factoring for a Business?

When it comes to financing short-term cash flow needs, factoring emerges as a valuable solution among the myriad options available to businesses. However, it’s worth noting that SMEs can sometimes face challenges.

1.1 – Defining Factoring

Factoring involves entrusting your customer receivables to a specialised and authorised factoring company, commonly known as a factor. Through this strategic move, your company can access instant payment-often partial-for your assigned invoices even before they’re due, effectively increasing your cash flow. It’s imperative to understand that factoring contracts come in various types, each with its unique characteristics that we’ll explore in detail.

1.2 – Who Can Benefit From Factoring?

Factoring caters to B2B professionals, as long as customer payments aren’t settled in cash. However, it’s critical to note that invoices tied to sales made to individual consumers are excluded from the receivable assignment.

1.3 – Approved Factoring Companies in Europe

Factoring is a regulated financial operation under the watchful eyes of authorities in each European Union member state. Rest assured, only financing companies and specialised credit institutions, known as ECS (European Credit System), approved by these regulatory bodies, have the green light to provide factoring services.

1.4 – Key Aspects of a Factoring Contract

When embarking on a factoring contract, it’s crucial to explore the following clauses:

• Scope of the receivable assignment (clients covered, any exclusions)
• Terms of the financial advance (factor’s retention rate for the guarantee fund, safeguarding against defaults)
• Effective debt collection methods and client awareness of the factoring arrangement
• Fair remuneration for the factoring company
• Optional credit insurance provisions
• Nature and frequency of audits performed by the factor on the company’s accounts

1.5 – Most Common Types of Invoice Factoring

Ready to explore the dynamic world of factoring contracts? They offer businesses different ways to manage factoring for their clients. Let’s uncover the key contracts below.

1.5.1 – Standard Factoring

Whether it’s a bank subsidiary, the company’s own bank, or a specialised financing firm, standard factoring ensures written disclosure for clients. They are fully informed and pay each invoice directly to the factor. Businesses with a streamlined administrative structure find organisational advantages to this approach.

1.5.2 – Exploring Different Factoring Contracts

The notified or semi-confidential factoring contract takes an unusual approach by informing customers about the financing arrangement right from the start. However, the company still controls customer accounts, including collection. When payment is due, customers settle their invoices directly with the supplier. The company then collaborates with the factor, providing updates on the collections linked to the assigned receivables for each period.

On the other hand, the non-notified or confidential factoring contract, which operates in stealth mode. Customers remain blissfully unaware of its existence. From their perspective, it’s business as usual, paying their invoices just as they would without factoring involvement. It’s an intriguing option that allows companies to navigate factoring discreetly while reaping the benefits behind the scenes.

2 – The Limits of Factoring in Financing: What You Need to Know

On the surface, factoring may appear as the concrete and immediate solution to B2B payment delays. However, it’s important to keep in mind that this financing option may not be suitable for all companies, especially small businesses like freelancers and SMEs. These businesses often face challenges when it comes to accessing financing.

2.1 – Partial Cash Advances and Customer Receivables

When opting for factoring, the requesting company typically receives only a portion of the invoice payment. This depends on the retention rate used to fund the guarantee fund. This creates an internal cash reserve within your accounting system, accessible by the factor in case of customer defaults. However, it’s crucial to consider that this financial retention impacts your cash flow and comes with associated costs that need to be carefully evaluated within the overall contract analysis.

2.2 – Short-Term Financing With Potential Costs and Flexibility Constraints

Before factoring, it’s essential to assess the total cost of the operation. The contract outlines the financing commission amount or rate, factoring fees, and administrative charges. Additionally, it’s imperative to account for the opportunity cost of locking funds into the guarantee.

2.3 – Financing for the Entire Customer Portfolio

With factoring, it’s worthwhile to note that all existing and future receivables are typically assigned. This means that you cannot selectively stop the operation or limit it to specific clients. From an administrative standpoint, this lack of flexibility restricts adjustments based on period-specific turnover or other individual considerations.

2.4 – Factoring and Its Impact on Commercial Relationships

Unless you choose a confidential factoring contract, your company may experience disruptions or weakening of its customer relationships. Involving a factor in the early stages can lead to the customer feeling overlooked. In standard factoring arrangements, the factor handles collections, excluding your company’s sales department.

2.5 – Credit Insurance Requirements by Factors

In addition to factoring costs, factors often require clients to obtain credit insurance contracts. This additional safeguard is requested by the factoring bank to mitigate non-payment risk. During the contract setup, the factor may even accept receivable assignments exclusively for clients covered by the designated credit insurer.

3 – Revolutionising Financing: Embedded Invoice Financing

Say goodbye to traditional factoring and embrace the future of finance! The business world is witnessing the rise of innovative financing methods that streamline short-term cash flow management and fuel company growth. In this digital era, embedded finance takes the stage, offering unparalleled operational convenience for occasional cash needs. Let us explain!

3.1 – What Is Embedded Invoice Financing?

Among the cutting-edge tools of embedded finance, embedded invoice financing takes the spotlight. It seamlessly integrates a financial solution into a product, be it a platform, marketplace, or SaaS. With a simple click, suppliers, service providers, and freelancers who collaborate with other companies can swiftly request instant payment for their invoices directly within the platform they’re utilising. Say goodbye to waiting! The process operates seamlessly in the platform’s back-office, ensuring a timely financial advance for the service provider, independent of the final client’s payment for the sales invoice. It’s finance on the go, redefining the game!

3.2 – Aria: Empowering B2B Invoice Financing With BNPL

At Aria, we empower digital businesses with our cutting-edge B2B BNPL (Buy Now Pay Later) solutions. Through seamless API integration, we revolutionise digital platforms, tech solutions and specialised SaaS providers’ invoice financing needs.

With our cutting-edge solution, clients can purchase services from providers without the burden of settling payment instantly. How do we do it? Aria advances the necessary funds, assigning the corresponding receivable to the final client’s invoice. We earn a commission on each individual financing transaction, rather than the total revenue for the period.

Use case: Streamlining Projects from Sourcing to Payment with Aria’s Deferred Invoice Financing Solution

• You Are: a B2B Marketplace, a Transactional SaaS, an ERP aiming to streamline user experience and optimise project management.
• Use Case: Imagine your platform manages the entire project lifecycle, from sourcing suppliers to issuing payment. Aria’s deferred payment solution integrates at the payment stage, providing granular, automated, and secure financing for one or several supplier invoices, regardless of their size. This allows for a smoother and faster process, with all data centralised in one place.
• Benefits:
  • Increased Acquisition and Retention: Offering instant invoice financing enhances user experience, leading to increased user acquisition and retention.
  • Immediate Payment for Vendors/Contractors: Suppliers benefit from immediate payment without any unnecessary wait times.
  • Maintain Cash Flow: Marketplaces, SaaS, and ERPs can keep their cash flow intact as Aria handles the invoice financing.
  • No Change for the Client: The buyer’s payment terms remain the same, ensuring no disruption or additional burdens.
• Implementation: Integrate Aria’s solution via an API. Our financing experts provide support throughout the process, ensuring the solution fits seamlessly with your unique invoicing, billing, and payment flows. This integration can be tested manually on initial financing requests. Aria’s deferred payment solution simplifies and speeds up the entire project process, improving user experience, and enhancing your platform’s value proposition.

You now have a solid understanding of factoring and its alternatives! As a visionary CEO or astute CFO leading a marketplace, DSP, agency, or SaaS company, if you’re determined to master your cash flow, supercharge business growth, and shield against risks, our team of seasoned financing experts is eagerly waiting to connect with you.