It would be interesting to start this discussion mentioning how trading receivables is common practice among micro, small and medium size companies in Brazil. Paradoxically, what may be an interesting option in order to fund businesses in the short term is also the cause of bankruptcy among businesses in their first three years of activity. Due to lack of efficient management, the majority of micro and small businesses won’t reach their third year of activity. Among the reasons there are lack of reinvestment in the business core activity; high factoring discount rates and delinquency. (Souza, 2007)
When it comes to the advantages of factoring, The Federal National Commercial Credit (2013) clarifies that trading receivables is not a loan; therefore, it is does not require an extensive credit review as bank loans would, which accelerates the funding process. Differently from banks that would look more into the business’ credit strength, factors look into the customer’s credit strength which might result in bigger lines of credit than what conventional banks would be able to offer. Another interesting point and quite different from the Brazilian scenario is that in the USA some factoring companies will follow up with the business’ clients in case the invoices are not paid on time. Those gentle reminders to the business’s clients often result in more timely payments and free the business’ staff of performing this kind of task. Nonetheless, the author explains the disadvantages of factoring and points out one of the main drawbacks: high discount rate. Similarly to the Brazilian factors, in the USA factoring companies will charge more than banks because of the transactional work with the invoices that the factor does in order to be able to provide money promptly. The difference in discount rates varies significantly from one factoring company to the other and at this point is extremely important that the business has a considerable knowledge on invoice factoring cost drives. Another disadvantage in terms of seasonal businesses with downward revenue is that factoring shrinks as businesses contracts.
According to Rao (2010) it is important that a company periodically reevaluates its budgetary and revenue needs. Another interesting way to obtain funds is through the company’s clients and vendors. Rao (2010) mentions that about half of the world beating entrepreneurs cited in his book were funded by their clients through advance payments. This is also a way to measure the client’s engagement to the business. Another example is Best Buy that was built based on the financing of large electronic firms. The author also cites small business grants and deduction of expenses in the company’s taxes as alternative ways to factoring and pursuance of financial stability.
Atrill, P. & McLaney, E. (2012) Management Accounting for Decision Makers. 7th ed. Harlow, England: Pearson education Ltd.
Souza, C (2007) ‘The Brazilian factoring industry and receivable investment funds: a successful partnership.’ ANFAC [online] Available: http://www.anfac.com.br/jsp/arquivos/documentos/estudodeutschebank.pdf (Accessed: December 28 2013)
Rao, D. (2010) ‘The 12 best sources of business financing ’. Forbes [online] http://www.forbes.com/2010/07/06/best-funding-sources-for-small-business-entrepreneurs-finance-dileep-rao.html (Accessed: December 28 2013)
Federal National Commercial Credit (2013) Advantages and disadvantages of factoring [online] http://www.federalnational.com/blog/postid/87/advantages-and-disadvantages-of-factoring.aspx(Accessed: December 28 2013)