Invoice Factoring is a type of asset based or invoice finance, where a company sells its unpaid invoices to a third party in exchange for a percentage of their value.
Sometimes known simply as ‘factoring’, or ‘debt factoring’, the process offers increased cash-flow for businesses struggling with late payments from customers and is often available to businesses that have been refused traditional bank funding.
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Factoring is the process of selling outstanding invoices (the 'debtor book') to a factoring company in exchange for an immediate advance.
It's a form of asset based finance where customer invoices are used as collateral.
How does Invoice Factoring Work?
The invoice factoring process works as follows:
- Invoice is sent to the client as usual
- Business signs an agreement with a factoring company who advances up to 80% of the invoice straight away
- Factor assumes responsibility for getting the customer to pay the invoice, usually after 30 or 60 days, depending on the terms.
- The remaining amount owed to your business is paid, minus the agreed factoring fee.
Factoring vs Discounting
Invoice Finance is an industry with its own terminology. Factoring and Discounting are the two main forms of invoice finance, differentiated by who retains control of the sales ledger.
Factoring requires factoring companies to take control of the invoice collection process, meaning your customers will become aware that your company is using a finance solution. For some businesses it may actually be advantage to have a third party handling the credit control as it can free up resources.
With invoice discounting, the borrower retains control of the credit control process as usual, meaning confidentiality can be retained.
Factoring Vs. Invoice Finance
Many people get confused between whether factoring is the same as invoice finance.
Invoice finance is actually the generic term for the whole area of accounts receivable finance. Factoring is the specific process of selling invoices to a third party (a factor) in exachange for a cash advance.
The main costs of invoice factoring are:
Factoring Cost - These vary widely depending on the sums of money involved, and the level of historic credit risk. They generally comprise the base interest rate plus the percentage set by the lender, usually 2-3%
Administration Fees - Some factoring companies charge an additional administration fee, on top of their quoted percentage.
Termination Fees - Occasionally, lenders will levy a termination fee if the invoice factoring agreement is concluded more quickly than the contract stipulated.
Credit Insurance - Unless the invoice comes from an extremely secure customer, the responsibility for the invoices’ full payment rests with the borrower. Most partners offer insurance, however, to protect the lender should this situation arise.
Is Invoice Factoring Suitable for Small Business?
Factoring isn’t suitable for every business, but in the right instance - particularly where a company has fewer invoices for larger amounts - it can be a finance solution which facilitates growth. Like any type of loan, the terms tend to improve significantly alongside the amounts borrowed so it isn’t right for very small businesses. Ideally suited for SME’s and larger, or those with a turnover of £50,000 minimum.
What is Single Invoice Factoring or Spot Finance?
One of the newer offerings within the invoice finance market is ‘single invoice factoring’ also known as ‘spot finance.’ This is where a company needs to utilise factoring for a single invoice, without entering into a long-term agreement.
Where can I find an Invoice Factoring Calculator?
We recommend Business Expert, which offers the UK’s only real-time invoice factoring comparison engine. This works exactly like a calculator in that you can input your particular details and receive instant quotes from the UK’s top providers, allowing you to compare the best rates. Click here to visit their website.
What Does Factoring Without Recourse Mean?
Most factoring is ‘recourse’, meaning the borrower retains liability for the debt should the outstandings invoice not be paid.
Non-Recourse Factoring, however, means that the lending partner has agreed to shoulder the risk, so it comes at a higher premium. In certain cases, the more expensive nature of non-recourse factoring is worth it for a business wishing to continue functionining without any concern for bad debts.
- Improves working capital quickly.
- Asset based financing can work for businesses who have been refused traditional bank funding since the risk assessment is weighted more towards the client’s invoice than the borrower’s company.
- Outsourcing responsibility for credit control and debt collection can free up hours of running the business more effectively. More efficient collections can also less the time it takes customers to pay their invoices.
- With a factoring agreement in place, some businesses find they can negotiate better rates with suppliers as a result of being able to offer more flexible payment terms
- Business owners won’t receive the full value of an invoice
- Customers who have their invoice collected by a third party may lose confidence in the financial integrity of your company
- Since traditional banks include invoices amongst your assets, you may become less able to get bank loans since your invoices will be owned by a third party.
Is Factoring Regulated in the UK?
Currently no asset based finance is regulated by the Financial Conduct Authority.
Is Factoring a Loan?
Factoring does not quality as a loan because it does not create any liabilities or put any assets at risk, as is the case with a traditional bank loan.
Instead, factoring is technically an advance on accounts receivable, meaning your company will not be accruing any debt by making use of it.
Is Invoice Factoring a Good Idea?
We're often asked whether invoice factoring is a good idea and the answer is yes, providing your profit margins are large enough to contain the cost.
It works best for businesses with a relatively high profit margin on a smaller number of invoices. In these instances even one late invoice can place a huge burden on the overall cash flow cycle. As such invoice factoring companies iron out this problem, rapidly improve working capital, and the finance simply becomes a normal part of business workflow.