Factoring invoices
Factoring is a simple and effectively way of financing a business. By factoring invoices, you are selling them to a factoring company – which will advance you a percentage of the value of the invoice, and which will take responsibility for collecting the payment from your customer. Instead of waiting 30, 60 or 90 days for your money – longer, if the customer isn't a prompt payer – you get most of the money within 24 hours of writing the invoice.
Once the factor has collected the amount outstanding from your customer, the fees charged for the factoring service are subtracted, and any remaining balance is remitted to you. Essentially, what factoring does is to take the debtors in your balance sheet and turn from 75 to 90 percent of them into cash.
Factoring invoices is an excellent source of finance for services companies, which often have little in the way of fixed assets and may find it difficult to raise conventional bank finance without collateral. If you're running a fast growing recruitment agency, for instance, you may not even own your own offices, and your assets probably run to a few computers and a handful of telephones.
On the other hand, you probably have a huge amount of money tied up in client invoices, payable on thirty day terms. That's if you're lucky and your clients pay on time; we all know just how many excuses a client can make, from 'we lost the invoice' to 'we don't have your bank account number'. By factoring invoices, you can free up the cash that is tied up in your sales ledger.
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If you're growing fast, you will have found the need to fund customers' credit terms soaks up cash and can put your business under pressure. In these circumstances, factoring can give your business headroom – enabling sales to increase without depriving the business of the cash it needs to function.
Unlike a bank loan, which is for a fixed sum and is a one-off transaction, factoring invoices will continue to raise money for you as the business grows. The amount of the advance automatically keeps pace with the level of business you are bringing in, as every new invoice you issue will receive a new advance from the factoring company. Factoring creates a flexible, revolving credit, with no need to extend your overdraft terms or ask for a new loan. There is also no fixed date for repayment – always a source of worry with a fixed term bank loan.
Of course, factoring invoices can also help manufacturing companies and wholesalers – anyone who is invoicing trade customers, and receives payment after they have had to pay for stocks and labour costs, can benefit. Obviously, the higher the level of debtors in the accounts, compared to other assets, the greater the benefit to the company.
Factoring invoices beneficial for young businesses
Start up and young businesses may find factoring invoices is a better source of finance than bank loans or overdrafts. Since by lending against invoices a factor can see the creditworthiness of the customers, and is in charge of collecting the amount owed, factors are more willing to lend to a business that may have a limited track record. Factors will not ask for directors of the company to put up personal assets as collateral, either.
Businesses which use factoring have a competitive advantage when they are bidding for large new contracts. Recruitment agencies and consultancy firms, for instance, know that staff have to be paid weekly or monthly, while customers may not pay for some time after that. Taking on new temporary contractors can damage the company's cash flow, and that may make the company cautious when it comes to expansion. But a firm that is used to factoring invoices knows it can get a significant percentage of its money as soon as it sends out the invoice – and that's enough to pay the staff. So taking on a big new contract isn't the headache that it could be.
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Another advantage of factoring uk is that you no longer need to pay staff to chase payments for you. The factor will take over the entire credit control process – all you need to to do is to issue the invoice, and send a copy to the factoring company. Considering that a full time credit controller costs about GBP 18,000 in salary each year, that can represent a significant saving to set against the cost of the factoring service. And sales staff are better off chasing new business than chasing old invoices!
Of course, factoring invoices involves giving up control of your sales ledger to the factor. If you aren't happy with that – for instance because you don't want there to be a third party in the relationship with your client – you can choose the alternative, invoice discounting. You retain control of the ledger, and your customers can't see that you have borrowed against the invoice – but in other respects invoice discounting is almost exactly the same as factoring.
Calculating the cost of factoring invoices
Like all finance, factoring invoices has a cost. It's calculated in two parts. The first is a fee related to the amount of turnover that has been factored, which is usually between half a percent and three percent of the total. The second is an interest rate, usually one or two percent above the bank base rate, charged on the amount outstanding. Invoice discounting charges the same type of interest rate but the service charge is substantially lower, reflecting the fact that you are retaining the task of collecting payment.
Although you can approach factoring companies or invoice discounters, there are advantages to using a finance broker like Touch Financial. Because they have extensive contacts within the sector, they will be able to find the best deals on the market and ensure you're not paying over the odds. They may also have access to better rates than are available to individual customers. Factoring invoices is quite a specialised area of finance, and an experienced broker can help ensure you get the right deal.
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Also in this section:
- Overview of invoice factoring
- Factoring UK – Who ‘s in the loop and why
- How to find the best factoring quotes
- Benefits of a factoring service
- Factoring invoices is beneficial for young businesses
- The benefits of using business factoring
- Understanding a factoring service
