Business start-up resources

A Practical Guide to Factoring

Invoices paid on timeInvoice or Debt Factoring is a method used by businesses to free cash from invoices that are unpaid. It's a common finance method that can release up to 95% of your sales ledger value immediately.

It's designed to boost cash flow by working with a third-party finance company that collects the debt from your customers on your behalf.

Factoring is not for everyone because it's not your business who deals directly with your customers. Some factoring companies may also chase the debt down more aggressively than you'd like for your customers.

What is Debt and Invoice Factoring?

Essentially businesses sell their invoice debt to a third-party collection agency who collects your sales invoices on your behalf. Most companies use factoring to improve cash flow, but it also releases the administrative burden of managing a Sales Ledger Department together with the issue of larger companies not settling their invoices on time.

There are many specialist companies offering this service including most major banks who have a subsidiary company. Factoring is a long-term commitment so you should check all agreements from several companies before signing.

You're likely to receive 85%-95% of the invoice value within 24 hours of handing over the debt. Your customer then pays the financier, and the agency passes over the balance to you net of their fees and any interest applicable.

Why Use this Service at All?

Many smaller companies won't have the resources or time to chase down debt from invoices. Although some larger organisations use factoring companies, it's mostly the smaller company owner that requires such a service.

They won't have (or require) the full-time resources of a credit controller or department because they might only raise a few invoices each month. They use these services because they get paid a large proportion of the sales value immediately and then know that their debt is carefully managed by an expert third-party.

The percentage fees are usually negotiable. The industry average is 5% that's paid to the factoring company leaving the company owner the time to run the operations of their business.

Using Factoring Brokers and Services

Like insurance and mortgages, there are specialist brokers in the UK who will find the right solution for your business. They use their years of expertise to find the right factoring company that is right for your circumstances.

What Should I Ask the Broker?

There are a number of questions that need answers.

  • How quickly will you receive your cash?
  • What percentage do you get up front?
  • How does the agency collect the debt?
  • What fees and interest will they keep from the ultimate settlement figures?
  • What is the length of the contract?
  • What termination period is there?

A Guide To Invoice Discounting

In a similar manner to the more commonly known invoice factoring finance, invoice discounting is a popular specialist finance method for businesses with larger turnovers. It's a method in which the company receives a majority of their invoice value and receives the balance less fees once the bill gets paid in full.

Overview

Typically, the business receives approximately 80% of the total value of the invoices generated. The balance, less fees and charges, is paid to the organisation when the customer pays the invoice value in full.

This method of financing is similar in nature to business factoring except that your company still collects the debt and maintains the customer relationship. This last point can sometimes be vital for larger businesses where they don't want another third-party contacting their client base chasing for payment.

The fees involved range from interest on the money advanced to fixed and variable charges. Invoices are usually the largest asset of a company. Using these methods improves cash flow and reduces the requirement to employ a Credit Control Department.

Invoice Discounting Factors

This method of financing is only available to existing businesses with turnovers in excess of £500,000 although these figures vary depending on the factoring company used. Brokers are available to find the best solutions although they will charge for their services. A good broker will be able to find the best company to use and negotiate the fees and charges payable.

Check any contract you sign as invoice discount companies will want to know your track record on debt collection and your existing credit control procedures. This process ensures your debts are recovered quickly from your customers.

Your customers are unlikely to know that you've outsourced your entire credit control function. You keep the relationship in-house, and it's this feature that clearly differentiates it from general factoring.

This benefit can be crucial for businesses who don't want the services of a loan company or intermediary communicating to their customers. If you're thinking of factoring and are a larger business, then this solution could be excellent for improving cash flow and working capital requirements.

What are the Fees Involved?

You'll most likely have to pay two types of fees. You'll pay interest on the amount of money loaned until your customers settle their debt. The fees will be an amount above the Bank of England base rate and vary between 1% to 3% depending on the company lending. Most will also charge a management fee of around 1%.

If you're thinking of using invoice discounting, then get quotes from several companies including the banks. Most banks provide these types of services to medium and larger businesses. Professional brokers are also available to choose the right solution and offer alternatives but do check any contracts for fees, penalties and notice periods.

Alternative Funding Methods

There are various other forms of finance businesses can access. Factoring is used to maintain a positive cash flow within a business rather than injecting working capital. Bank loans are the most common form of finance mostly used for expansion or the purchase of assets. Read more about other financing options available for your new or existing business venture.