Disadvantages of capital loan and debt factoring are many as much as its advantages abound. Companies and private organizations including individuals whose aims are to venture into businesses suckle the myriads of benefits which securing capital loans and debt factoring bring to their table mostly in times of need.
However, nothing is without its own pros and cons no matter how impeccable it looks. This is why you must patiently go through the disadvantages that capital loan and the other one mentioned earlier carry–which may at the end of the affect your business or you personally. But first, let us know what capital loan and debt factoring mean.
Capital Loan means any interfund loan, or portion thereof, made for the purpose of financing the design, acquisition, construction, installation or improvement of real or personal property and not for the purpose of paying operating expenses. In other words, it is also a type of funding that must be repaid. This form of funding is comprised of loans, bonds, and preferred stock that must be paid back to investors. Unlike common stock, loan capital requires some type of periodic interest payment back to investors for use of the funds. Usually, it is offered by a bank or alternative lender to finance a company’s everyday operations.
No matter how, these loans are not used to buy long-term assets or investments and are, instead, used to provide the working capital that covers a company’s short-term operational needs. Examples of these capital loans are bank overdrafts, bank term loans, and lastly, debentures.
On the other hand, debt factoring is a way by which organizations absorb possible shock, so to put it simply. It can be succinctly put as an expedient financial move which involves a business selling their invoices to a third party at a discounted price in order to bypass the hefty waiting times which are associated with invoice payments. As expedient as it is, it saves a lot as much as it endangers the economic weight of a company or business by liquidation in cases when it goes wrong unexpectedly.
The most common example of debt factoring is invoice finance. This means businesses can unlock cash tied up in unpaid invoices. The facility is practically limitless and therefore suits a fast-growing business. There is no security required unlike a loan or overdraft.
Disadvantages of Capital Loan and Debt Factoring.
What then are the cons, that is, the disadvantages of capital loan and debt factoring? You will get to understand some of the ways by which capital loans and debt factoring can adversely affect your business if due care is not taken to really sort them or even find a smart means to avoid taking them entirely.
Below are the flies in the ointment of capital loans and debt factoring:
1. The Flaws of Capital Loan
- Some loans have higher interest rates especial the term loans which are used to take care of huge projects. Meanwhile those with manageable interests too have a risk of accumulating in cases where businesses default in their payments.
- It is hard sometimes for businesses to find good credit for a loan. This often happen when banks are running on capital loss and cannot provide a hand in times of your need. Therefore, over reliance on capital loans might just be a mirage.
- Another one of these disadvantages is the risk of interest rate rising if your loan includes floating rates, which could make your project no longer viable.
- Loan terms can include a partial funding requirement that says if you want to borrow an amount, you need to invest a certain amount of your own money. Many loans may even add processing charges.
- This is mostly encountered by organizations and businesses in the hand of banks to whom they find themselves at their mercies. That is, the fact that some loans include prepayment charges and penalties which are by nature unfavorable and possibly unbearable but because of the urgency of need for a capital loan, this red signs are obeyed sheepishly oftentimes to the hurt of the company’s financial health.
- Loans may also have a strict repayment schedule to adhere to. This however may lead to the final liquidation of the borrower, that is, the business in question. The business also gets to pay more than purchase price when getting a loan.
2. The Flaws of Debt Factoring
- Debt factoring can be an expensive form of short-term financing. Factor rates can translate into APRs over 100%—much higher than you see with other types of financing. And because debt factoring depends on how long it takes your customers to pay, it is more difficult to evaluate the cost of this type of funding upfront.
- Debt factoring undoubtedly affects your relationships with your customers as it somehow makes them feel un-comfy with what may be the end (financial trouble) of the whole thing. Perhaps one of the most notable debt factoring disadvantages is that by working with a factoring company, you will have added a third party to your relationships with your customers.
- Debt factoring companies require that you enter a long-term agreement with them—whether this means agreeing to a certain length of time or a monthly minimum of invoices. Not only does this mean you will be continuously receiving less than the total value of your invoices, but it also puts you into a factoring cycle that can be difficult to break.
- Even though a top advantage of debt factoring is fast access to capital, on the other side of the coin, a huge disadvantage is that by working with a debt factoring company, you may lose out on the total amount of profits you should get.
- When customers do not pay their invoices, it is big problem for the business in question. Most debt factoring agreements are likely to be recourse which puts you at risk of huge loss and run-down for a business that is already having cash flow problem.
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