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Spot Factoring: All you Need to Know

By Annapoorna

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Updated on: Mar 29th, 2023

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15 min read

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It isn’t uncommon for companies, especially new and small-scale enterprises, to experience cash flow crunches while running their operations. But with interest rates rising, availing of business loans and overdraft facilities has become a costly affair. That’s where spot factoring comes to the rescue of SMEs. 

So, what is spot factoring, and how does it help companies in meeting their short-term capital needs? Let’s find out.


Meaning of Spot Factoring 

Spot factoring is a type of invoice financing which involves a business selling its accounts receivable, also called invoices, to a factoring company in exchange for immediate cash. However, the company receives only a percentage of the invoice’s value upfront; the rest is received after the customer makes the full payment.

Spot factoring is also known as single invoice factoring and selective invoice discounting, as it encompasses the factoring of only one invoice at a time. It is a short-term financing solution that allows businesses to manage their cash flows, as they no longer have to wait for the client to make the full payment. 

So, how does spot factoring work? We explain the process below.

Process of Spot Factoring 

While the mechanics for spot factoring may differ per the factoring company, the process remains largely the same. The steps involved in the process of spot factoring are as follows:

  1. The enterprise will choose a single invoice that it wants to factor in and submit it to the factoring company for review.
  2. The factoring company will evaluate the creditworthiness of the company's customers and determine the value of the invoice.
  3. After approval, the factoring company will advance a certain percentage of the invoice’s value (between 70% to 85%) to the business within 24 to 48 hours.
  4. Finally, the factoring company will remit the remaining amount to the enterprise after the business' customer pays the invoice in full. This amount will exclude the fees and expenses paid to the factoring company.

To illustrate, let’s assume a company ‘X’ has experienced glitches in its operations due to machine malfunctioning and wants to replace them. But ‘X’ does not have enough cash to fund the purchase costing Rs.4 lakhs, without compromising on meeting its salary payments. In such a scenario, ‘X’ can opt for spot factoring to generate cash temporarily. 

So, let’s further assume that the company submits an invoice worth Rs.5 lakhs to a factoring company. After running a credit check on the customer, the factoring company decides to extend 80% of the invoice’s value, i.e., Rs.4 lakhs upfront, subject to a 4% commission. 

Consequently, after the customer pays the invoice of Rs.5 lakhs, the factoring company will pay the remaining sum of Rs.80,000 (Rs.1,00,000 - Rs.20,000) at 4% commission to the company ‘X.’

But why should businesses opt for spot financing over other short-term financing options? Let’s elaborate.


Advantages of Spot Factoring

There are several advantages to spot factoring, which are listed below.

Quick Cash Flow

Spot factoring enables firms to obtain a specific percentage of their invoice’s value within 24 to 48 hours without waiting for the invoice’s maturity.

Flexibility

In spot factoring, firms retain flexibility, as they get to choose which invoices to factor in and when. Thereby, they can manage their cash inflows on a per-invoice basis.

Low Risk 

Unlike business loans that carry significant risk, spot factoring is a low-risk proposition as the funds are advanced against a completed transaction. Besides, the factoring company also carries out a credit check on the customer. Thus, enterprises can access cash without taking on any additional debt on their financial statements.

Easy Process

The process of spot factoring is quick and straightforward, as it merely requires the business to submit its invoices for review by the factoring company.

No Long-term Contracts

The biggest advantage of spot factoring lies in the fact that it is a one-off transaction. A company can factor in a single invoice and be done with it. There is no need to submit all the company invoices, nor is the company subjected to any minimum invoicing limits.

No Amount Limits

Unlike overdrafts, which are limited to a specific limit, spot factoring enables companies to inject a considerable sum of money, provided the invoice is highly-valued.

No Requirements for High Credit Scores

Since the factoring company is concerned with the creditworthiness of the customer and not of the business, even companies with poor credit histories can utilise spot factoring.

No Collateral 

Since the funds are extended against the invoice, there is no need to pledge additional collateral. 

Disadvantages of Spot Factoring

As with all credit products, spot financing has some inherent risks. Below, we enumerate some of the disadvantages to spot factoring.

Higher Costs

Spot factoring involves giving up a certain proportion of the invoice value as a fee to the factoring company. These fees can shoot higher if the factoring company perceives the customer’s credit risk to be higher.

Limited Recourse

By selling its accounts receivable to a factoring company, the firm loses control over its sales ledger and the collection process. Therefore, it must rely on the factoring company to manage the payment of its invoices and funds recovery.

May Harm Customer Relationships 

Since it is the factoring company that chases payments, it can adversely impact the firm-customer relationship if the tactics employed are cold and aggressive. They may also indicate that the company isn’t doing well.

Which Businesses Should Opt for Spot Factoring?

Generally, spot factoring is suitable for businesses that are amenable to giving up a portion of their invoice in exchange for quick access to cash. Other businesses likely to benefit from spot financing include the following:

Small Businesses

Since small businesses have trouble accessing traditional financing options, spot factoring can be the key to accessing immediate cash and better cash flow management.

Businesses with Many Invoices

Businesses that are struggling with cash flow management, despite having access to plenty of accounts receivable, may find spot factoring a fitting solution to their funding woes. Additionally, they can inject larger sums of money into their business, if the invoice value is high.

Businesses with Long Payment Cycles

For businesses engaged in construction and manufacturing industries that have long repayment cycles, spot factoring can serve as a useful tool for availing of short-term finance. 

Businesses with Creditworthy Customers

Spot factoring is a more suitable alternative for companies with creditworthy customers. This is because their high credit scores get reflected in the form of lower fees and commissions charged by the factoring company.

Seasonal Businesses

For enterprises experiencing extreme variations in their sales and invoices due to their seasonal nature, spot factoring is a noteworthy short-term financing option.

Spot Factoring vs Long-Term Contract 
 

As mentioned above, spot factoring entails the immediate sale of a single invoice, thus ending after this transaction is completed. This is unlike the long-term contracts (contract factoring) that constitute the factoring of multiple invoices over a long period of time.

Here is a comparison of spot factoring and longer-term contracts:

BasisSpot FactoringLong-Term Contract
MeaningSpot factoring means selling a single invoice to a third party for quick cash turnaround.Long-term contracts involve an agreement to sell a minimum number of invoices each month to a factoring company for generating regular cash inflows.
Contract’s LengthSpot factoring lasts for a short term as it is usually restricted to a single invoice.As the name suggests, long-term contracts last for a relatively longer duration as the contract includes the factoring of multiple invoices.
FeesSpot factoring is relatively more expensive as it is a one-time service. Long-term contracts charge lower fees as the costs are averaged out over multiple invoices. However, factoring companies do charge a minimum annual fee for the contract.
Creditworthiness of customersIn spot financing, a credit check is carried out only on the customer whose invoice has been submitted for factoring.Under long-term contractual agreements, creditworthiness is evaluated for the entire contract.
RiskSpot factoring carries lower risks as it is limited to a single invoice.Long-term contracts are relatively high-risk as they include multiple invoices.
PaymentUnder spot financing, the funds are usually released within 24 to 48 hours of application.In long-term contracts, it can take longer to extend money, sometimes even 30 to 90 days.
SuitabilitySpot financing suits companies with sporadic or seasonal cash flow needs.Long-term contracts work well for companies in constant need of cash and don’t mind paying an annual fee for the option to discount a certain number of invoices per month.

 

Cost of Spot Factoring

Typically, the cost of spot factoring depends on several factors, including the value of the invoices being sold, the company’s niche and trading history, and the creditworthiness of its customers.

Having said that, factoring companies usually charge 1% to 5% of the invoice value as a fee for their services. Additionally, they may charge other fees, such as an administrative fee or an application fee. 

Conclusion

Spot factoring is an excellent short-term financing option for businesses looking to generate quick cash without taking on additional debt on their balance sheets. However, they must carefully consider all the terms and costs involved in the financing arrangement before entering into a contract. 

About the Author

I preach the words, “Learning never exhausts the mind.” An aspiring CA and a passionate content writer having 4+ years of hands-on experience in deciphering jargon in Indian GST, Income Tax, off late also into the much larger Indian finance ecosystem, I love curating content in various forms to the interest of tax professionals, and enterprises, both big and small. While not writing, you can catch me singing Shāstriya Sangeetha and tuning my violin ;). Read more

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