What is the difference between factoring and debt collection?
While invoice factoring involves current unpaid invoices—no more than 30 days old—debt collection deals with invoices that are at least 60 days past due.
Factoring Doesn't Cover Old Debt
One of the most significant differences between the two is when the collection process kicks off. Debt collectors focus on outstanding invoices or older debts—usually those that a business has already tried to collect on without success.
Factoring is not considered a loan, as the parties neither issue nor acquire debt as part of the transaction. The funds provided to the company in exchange for the accounts receivable are also not subject to any restrictions regarding use.
Besides the fact that such financing solutions are usually exclusive to B2B commerce, disadvantages of debt factoring should not be neglected. They include loss of profit, downgrading of the credit ratio, loss of control of your business' image with your clients and... more debt.
While these two services may sound similar, a debt buyer vs. collector performs different tasks. Debt buyers purchase past-due accounts from lenders, whereas debt collectors work on behalf of whoever owns the debt in an attempt to get the borrower to pay.
One of the most common misconceptions of factoring companies is that they serve the same function as a debt collector—this couldn't be further from the truth. These two businesses serve two completely different purposes.
Worked example of Debt Factoring
The business needs to raise cash to improve its liquidity. The debt factoring company then collects the invoice payment from the customers and sends the remaining 10% of the value of the invoice to the business LESS a fee – typically around 3%.
It's a cash advance and an alternative way to get money when you need it. Invoice factoring isn't creating a debt: you're simply selling the collection rights to a debt you already own — unpaid invoices — in exchange for faster access to those funds.
Factoring is like a credit card where the bank (factor) is buying the debt of the customer without recourse to the seller; if the buyer doesn't pay the amount to the seller the bank cannot claim the money from the seller or the merchant, just as the bank in this case can only claim the money from the debt issuer.
A factoring agent is an intermediary agent that provides cash or financing to companies by purchasing the account receivable. In exchange for your account receivable and factoring fee, the agent provides a cash advance, typically worth up to 90% of the invoice's value, within 1 or 2 days.
What is debt factoring in simple words?
Debt factoring is when a business sells its accounts receivables to a third party at a discount, enabling companies to immediately unlock cash tied up in unpaid invoices without having to wait the usual payment terms. Debt factoring is also another term used for invoice factoring.
Improved Cash Flow: The most significant advantage of debt factoring is the immediate boost it gives to your business's cash flow. Instead of waiting for customers to pay their invoices, you get most of the cash upfront, which can be a lifesaver for businesses with tight cash flows.
Using a debt collection agency can be costly - the commission on the money recovered is typically 8 to 10 per cent for commercial debts. You may lose your customer if the agency has poor communication skills. If the agency takes a heavy-handed approach, your reputation may be damaged.
Summary: Ultimately, it's better to pay off a debt in full than settle. This will look better on your credit report and help you avoid a lawsuit. If you can't afford to pay off your debt fully, debt settlement is still a good option.
In fact, if you're ready to negotiate on a debt, you'll probably be better off talking to and paying the creditor, not a collection agency.
All told, it's really not a great thing to let your debt get to the point where it's gone into collections. If you're able to reach out to your original creditor and work out a payment plan first, you'll generally be in a better position.
Debt collectors cannot harass or abuse you. They cannot swear, threaten to illegally harm you or your property, threaten you with illegal actions, or falsely threaten you with actions they do not intend to take. They also cannot make repeated calls over a short period to annoy or harass you.
Professional and business services providers who could benefit from invoice discounting and factoring include architects, engineers and legal firms, as well as companies in the financial sector. When a company is in difficulty, sometimes a process of financial and/or operational restructuring is needed.
The business owner receives cash for the invoice amount, usually less any fees, ahead of the payment terms. The business owner's customer, who is responsible for paying the invoice, instead pays the invoice amount to the factoring company according to the original payment terms.
Debt Factoring usually exists as a short-term cash flow measure for businesses that want to increase their working capital cycle.
Is factoring a loan?
Business factoring loans are not asset based lending even though it is based on an asset: your invoices. Since you're not borrowing money that has to be repaid, it's not considered a loan.
The answer is that Factoring can be both a short-term or a long-term tool; that's what makes it such a powerful solution.
Suppose a business's customer does not pay the invoice within the recourse period (typically 90 days). In that case, the business is responsible for buying back the unpaid invoices from the factoring company or replacing them with other invoices of equal value. If your customer goes bankrupt, you still own the invoice.
Invoice factoring can provide immediate access to working capital to help cover a funding gap caused by slow-paying customers. Improved cash flow. Factoring can also allow you to keep loyal customers on longer payment terms while still improving your cash flow to help you grow your business. Easier to qualify.
Many businesses fail due to poor cash flow, and invoice factoring can keep yours healthy – as long as you use it wisely. Cheaper and easier than a bank loan - Invoice factoring is usually cheaper than a bank loan and easier to obtain, making it good for short-term funding needs.
