Companies are often attracted to the idea of spot factoring because, on the surface, it looks like a simple solution. You finance a single invoice, or perhaps a couple invoices, and then conclude the relationship. However, financing a single invoice can have some drawbacks. Often, spot factoring is not the solution you actually need.
From this article, you will learn:
- What spot factoring is
- What selective factoring is
- Disadvantages of spot factoring
What is spot factoring?
Spot factoring is a type of invoice financing in which the client finances a single invoice. Some clients use this service for one time only, whereas other clients see it as an alternative to finance an invoice, from time to time, when the need arises.
Although clients may use this service occasionally, it is usually handled as a single transaction with no expectation of future business. In theory, spot factoring may look like an ideal product for some. However, as we will see, the product has some limitations.
What is selective factoring?
Selective factoring is a type of invoice factoring that fits somewhere between conventional factoring and spot factoring. The solution allows the client to choose which invoices and customers to factor.
A selective factoring program provides the client with full control of their financing. The client can decide which customers to factor and – for each of those customers – which invoices to finance. Furthermore, factoring companies that offer this solution also allow the client to choose when to finance the invoice, which can save money on fees. To learn more, read “What is Factoring?”
What problem are you trying to solve?
Which product is better for your company is determined by the problem that you are trying to solve. Do you have a one-time cash flow problem due to a slow-paying client? Is this problem due to a single invoice? In this case, factoring the single invoice using spot factoring may be the right solution.
However, in our experience, this is seldom the case.
In reality, most small companies encounter cash flow problems from time to time, especially if they are growing. This problem is common for companies that don’t have large cash reserves. And these problems don’t happen just one time because of a single, large invoice. Instead, they happen several times a year. In this case, a selective factoring facility provides you with the flexibility you need.
Disadvantages of Spot Factoring
Although spot factoring looks like a flexible solution on the surface, it has a number of disadvantages:
#1 It’s expensive
The premise behind spot factoring is that your company will use the service one time only. As a result, the factor has only one transaction to recover due diligence costs, working capital costs, and to make a profit. Since they cannot spread their costs and risk over multiple transactions, they must charge a premium to make the transaction worthwhile.
#2 Spot factors can work only with large invoices
Factoring is a volume-based business – profits are tied directly to the amounts that clients finance. A spot factor expects you to factor a single invoice; therefore, the size of the invoice must be worthwhile. Most spot factoring companies work only with invoices that are $300,000 or more (this amount varies).
#3 It may affect your client relations
In most factoring relationships, clients are sent a notice of assignment advising them that the invoice is being financed and that payments must be remitted to a new address. This notice is usually not a problem for a conventional or selective factoring line, because this notice is sent once and the change is easy to make
However, in a spot factoring relationship, you have to send another notice to the client once the transaction concludes. This second notice advises your customer that you are no longer financing invoices and to remit new payments to the old address. As you can imagine, your customer’s Accounts Payable department will be inconvenienced by these constant changes. This point brings us to the final disadvantage of spot factoring.
#4 Payments may be sent to the wrong address
If you are factoring a larger invoice from a regular customer, but are not financing their other invoices, you end up with a complicated payment stream. For some invoices, your customer must send the payment directly to you. Other invoices, however, should be paid to the factor. This arrangement can be confusing and may cause payments to be sent to the wrong address.
Is selective factoring better?
In most cases, a selective facility is the better choice because companies that have a cash flow problem usually need to finance more than a few invoices to solve their problem. However, that doesn’t mean they need to factor every invoice. A selective facility provides your company with the right level of financial control, enabling you to better manage your working capital.
Looking for factoring?
We are a leading factoring company and can provide spot factoring and selective factoring solutions. For a quote or for more information, fill out this form or call us toll-free at (877) 300 3258.