Can debt factoring help reduce Days Sales Outstanding?

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The ‘cost of doing business’ crisis has meant many organisations are considering debt factoring as a viable option for the first time. 

It’s perhaps understandable in the current climate. Cash flow has been worsening for many businesses rather than improving. 

And while business sentiment could be beginning to turn a corner, the CBI’s Business Optimism Index has been negative for the past 12 months.

The economic outlook means finance managers are forced to explore other options when faced with a need to improve their current Days Sales Outstanding ratio. However, this action comes at a cost and with risk. 

While the UK economy is currently forecast to narrowly miss recession, some businesses will still be considering debt factoring as an option because of the weak outlook – it typically increases during economic downturns.

In this article, we’re going to explore debt factoring – and whether it is something which can help reduce Days Sales Outstanding and improve business resiliency. 

What is debt factoring? Advantages and disadvantages explained:

Let’s start with a definition:

"Factoring is a financial transaction and a type of debtor finance in which a business sells its accounts receivable (i.e., invoices) to a third party (called a factor) at a discount. A business will sometimes factor its receivable assets to meet its present and immediate cash needs."

As an alternative term to invoice factoring, debt factoring is when invoices from accounts receivables are sold on to a third-party factoring company at reduced value.

The advantages: As well as the factoring company taking on the ‘risk’ of the customer not paying an invoice, it creates a short-term option to improve cash flow, and thus reduce Days Sales Outstanding.

It gives the business immediate access to cash, with no collateral required. So, in some circumstances this could be a better option for finance teams than taking out a secured loan or using a costly overdraft facility, for example.

The disadvantages: There are some risks involved. Businesses can get caught up in the pitfalls of recourse versus non-recourse agreements.

Recourse is about who carries the risk in case a buyer does not pay. Under a non-recourse agreement, when the invoice factoring company, such as the bank, comes to collect on the invoice if there is a non-payment, they will have to cover the loss.

In a recourse agreement, in the same situation, the seller would have to pay back what was lost. Because of the associated risk for an invoice factoring third party, non-recourse agreements can be more expensive. So, while the business gets the cash they need immediately, they will pay a premium for this additional security if it is a non-recourse agreement.

Coupled with a loss of control over collections, it means a business can still be stung if the buyer does not pay.

Should a business use debt factoring?

Even after balancing these positives and negatives, the picture can still be unclear. The right option involves weighing all these factors to determine what is right for your business and risk appetite.

Given the current economic climate, the strength or weakness of your current book, as well as the level of understanding of your customers’ situations, should all be factored into consideration.

With that in mind, if you are considering looking to retain control of your invoices, or explore alternatives, it is imperative the right tools are in place to manage cash flow and Days Sales Outstanding.

Why D&B? Using data to give you a complete picture of your customer

It all starts with the power of data – which can give you a more complete view of customers, understanding their risk profiles, and likelihood to pay on time.

Tools such as the D&B® Delinquency Score can predict how likely a business is to pay in future. It’s insights like this which can sway if debt factoring is right for you right now, with your own cash flow in mind.

Credit and receivables risk can be managed using D&B Finance Analytics – helping to minimise bad debt, reduce Days Sales Outstanding, while also improving cash flow. By combining data on more than 500 million large and small global business entities, it gives credit teams the richest picture on who they are doing business with.

Because Dun and Bradstreet has access to the deepest pool of global data, UK businesses can get a view on both suppliers and customers in other markets.

While the economic outlook today might not be the rosiest, using data to better understand customers will arm businesses with the right insights to make faster, more accurate decisions.

Are you considering debt factoring to reduce Days Sales Outstanding? We help businesses – large and small – to make smarter decisions. D&B Finance Analytics combines powerful insights and technology to help finance teams manage risk, increase operational efficiency, and reduce costs, but if you would like to get started with a smaller number of International or European credit reports only, you can now order them online.