What is Invoice Factoring and How Can it Help?
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’, 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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What is Meant by Factoring?
Factoring is the process of selling unpaid invoices to a third party (a factor) 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 ‘factor’ who advances up to 80% of the invoice straight away
- Factor collects the invoice, usually after 30 or 60 days, depending on the terms of invoice
- The invoice balance is paid, minus the agreed factoring fee.
Factoring vs Invoice 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 the ‘factor’ or lender to take control of the invoice collection process, meaning your customers will become aware that your company is using a finance solution.
With invoice discounting, the borrower retains control of the invoice collection process as usual, meaning confidentiality can be retained. Although the loss of confidentiality is often mooted as a disadvantage of factoring, some businesses find that handing over the responsibility for debt collection can free up valuable time for running other aspects of the business.
What are the Costs of Invoice Factoring?
The main costs involved are:
Factoring Cost – These vary widely depending on the sums of money involved, and the level of historic risk. They generally comprise the base interest rate plus the percentage set by the lender, usually 2-3%
Administration Fees – Some partners 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 £250,000 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 ‘non-recourse’, meaning the borrower retains liability for the debt should the invoice not be paid. Factoring ‘without recourse,’ however, means that the lending partner has agreed to shoulder the risk.
- Improves the cash-flow cycle quickly
- 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 debt collection can free up hours of running the business more effectively.
- 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
- You won’t receive the full value of your 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.
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 irons out this problem and can become a normal part of business workflow.