Debt Factoring Advantages and Disadvantages

Although cash flow is the heartbeat of every business, many small and medium-sized enterprises (SMEs), as well as self-employed people in the UK find it challenging to keep it steady. If that's the case with you, you should consider debt factoring advantages and disadvantages. And while exploring ways to keep your finances on track, consider tools like Wise Business for managing payments efficiently.

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Customers may take their time paying invoices and in such situations, working capital can run dry, especially when you need it the most. Debt factoring is a way to quickly boost your cash flow – by using your unpaid invoices as leverage. It's a popular way to bridge the gap between sending an invoice and getting paid for many SMEs. But like with many other financial tools, it has its pros and cons.

What is debt factoring and how does it work?

Debt factoring, also known as invoice factoring or accounts receivable factoring, is a convenient financial tool. It allows you to free up cash tied up in unpaid invoices. It works in a simple way — instead of waiting for clients to pay their bills, you can sell these invoices to a third-party factoring company at a discount. In return, you get an immediate cash advance – often up to 90%¹ of the invoice value.

In itself, it's designed to be a pretty straightforward way for a business to access funds tied to unpaid bills. Here is how it works²:

• A business provides goods or services to customers and sends out invoices with payment terms – 30, 60, or 90 days.
• Instead of waiting for customers to pay the bills, a business then sells these outstanding invoices to a factoring company, which buys them at a discount.
• Once the factoring company has evaluated the invoices and approved them, they pay out an advance, usually up to 90% of the value. This gives the business immediate working capital to cover expenses, invest in growth, or bridge cash flow gaps.
• The factoring company takes over the responsibility of collecting payment from the customers. They'll handle the follow-ups and make sure the invoices are paid in full.
• Once the client settles their invoices, the factoring company sends the remaining balance to the business, excluding the service fee. The fee depends on factors³ such as the value of invoices and customers' creditworthiness.

Debt factoring example

Imagine your business has an unpaid invoice of £10,000. You then decide to sell it to a factoring company, which advances you £9,000 immediately (90% of the value). The company collects the full payment from your customer and sends you the remaining £1,000 but subtracts their fee (for example, £200).

Debt factoring advantages and disadvantages overview

The table below shows the pros and cons of debt factoring.

What are the advantages of debt factoring?

When it comes to businesses that are facing cash flow challenges, there are several benefits of debt factoring. Most notable are the following:

• You don't have to wait for customers to pay invoices. Factoring companies provide an instant cash advance and give the funds required for expenses, to pay suppliers, or to invest in further growth.
• Factoring allows businesses to better manage their finances with consistent cash flow. It's especially helpful for businesses that have seasonal fluctuations or long payment cycles.
• Since a factoring company takes over the collection process, it saves time and effort and allows a business to focus on operations instead of chasing payments.
• When collections are outsourced, an enterprise can reallocate resources to other areas of the business, such as sales, marketing, or operations.
• Factoring is tied to a sales volume, so as a business expands and generates more and more invoices, it can access additional funding without renegotiating the terms.

What are the disadvantages of debt factoring?

Despite its advantages, there are also some potential debt factoring disadvantages. Businesses should consider the following:

• Factoring companies charge for their services and often take a percentage of the invoice value. These costs can add up, particularly for businesses with tight profit margins.
• Some customers may not feel comfortable when dealing with a third party for payments, and it could, in turn, strain business relationships.
• Factoring companies typically only accept invoices from low-risk customers, and not all invoices may qualify.
• Relying too heavily on factoring for cash flow can lead to financial instability if the service becomes unavailable or too expensive.
• When a factoring company takes over invoice collections, a business loses control over how customers are contacted, and it may hurt a business's reputation.

What to consider before choosing debt factoring?

Is debt factoring the right fit for your business? This depends on several factors, as debt factoring has both benefits and potential drawbacks. Generally, it's most suitable for B2B companies that offer trade credit and are dealing with delayed payments, especially those with an annual turnover of over £50,000. Startups and businesses with limited credit options may also find it useful if they have outstanding invoices to leverage.

However, this solution can also be costly, with fees that reduce profit margins, particularly if used frequently or as a primary funding method. If you can afford to wait for customer payments or qualify for low-interest business loans, these options might be more cost-effective in the long run. Now, let's consider a few more questions.

Is it financially viable? While the solution provides quick access to cash, the associated costs can significantly eat into your profits. If your business has numerous outstanding invoices, the fees from frequent factoring can quickly add up.

Are you comfortable with short-term debt? If you decide to use a factoring company, you're effectively taking on short-term debt. Also, the cash you receive upfront is essentially an advance for which you pay a fee.

Will it affect customer relationships? Think about whether your customers will perceive the use of a third-party invoice collector as something negative. While it can help with operations and cash flow, some clients may view it as a signal of financial difficulty, which can impact your reputation.

Alternatives to debt factoring

If debt factoring isn't the right fit for your business, whether because of its costs, the need to maintain control of accounts receivable, or your business model, there are other funding options, too.

Small business loans are an easy way to access capital. These loans typically provide a lump sum of money that you repay in instalments over time. Like debt factoring, loans can help manage cash flow, cover day-to-day expenses or fund business growth. However, you'll need to factor in regular repayments – usually on a monthly or weekly basis.

If taking on additional debt isn't appealing, equity financing might be worth taking into account. This solution involves raising money by selling shares in your business. The trade-off, however, is that you're giving up partial ownership of the company.

Business grants offer an excellent way to secure funding without taking on debt or sacrificing ownership. Government agencies, non-profits, and other organizations often provide grants tailored to specific groups, industries, or business goals. For example, you might find grants for veterans, women entrepreneurs, or businesses operating in specific states. The downsides? Competition for grants can be quite fierce, and the application process can prove to be time-consuming.

FAQs - debt factoring advantages and disadvantages

What is debt factoring, and how does it work?

Debt factoring involves selling your unpaid invoices to a third-party company for a cash advance. In addition to paying you a portion of the invoice amount up front, the factoring company handles client payment collection. Once your customers pay, the remaining balance (minus fees) is transferred to you.

What are the main advantages of debt factoring?

Debt factoring offers several benefits, including improved cash flow, reduced admin burden, flexibility, and access for startups or businesses with bad credit.

What are the disadvantages of debt factoring?

Although it offers numerous benefits, there are certain drawbacks included, too. They are mainly costs, customer perception, loss of control, and invoice eligibility limits.

Is debt factoring suitable for all businesses?

Debt factoring is best for B2B businesses with steady invoice volumes and creditworthy clients. It's not ideal for B2C companies or businesses with low invoice turnover. Startups or businesses with bad credit may find it helpful, but it's essential to weigh the costs and potential impacts on customer relationships.

Will my customers know I'm using a factoring company?

Yes, most factoring arrangements require customers to make payments directly to the factoring company. This means they'll be aware of the arrangement, which may affect their perception of your business.

Is debt factoring right for your business?

Debt factoring can be a great financial tool, especially if a business is struggling with cash flow due to delayed customer payments. It offers immediate access to working capital and frees up resources for day-to-day operations. However, it comes with some drawbacks. The costs, potential impact on customer relationships, and dependency risks mean that it's crucial to evaluate whether this solution aligns with your long-term business strategy.

If your business operates internationally, Wise Business can simplify managing cross-border finances. With many convenient features, Wise Business helps you keep costs down.

Receive international payments with Wise Business

Receiving international payments doesn't need to be complicated.

When it is simple for your customers abroad to pay their invoices that means smoother cash flow and more financial stability to your business.

Wise can help UK businesses get paid by customers in multiple currencies, with low fees and the mid-market exchange rate.

Your Wise Business account comes with local account details to get paid in 8+ major foreign currencies like Euros and US Dollars just as easily as you do in Pounds.

All you need to do is pass these account details to your customer, or add them to invoices, and your customer can make a local payment in their preferred currency. You can also use the Wise request payment feature to make it even easier and quicker for customers to pay you.

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Sources used in this article:

Sources last checked March 30, 2025