When you factor an invoice someone else buys it from you, usually within just a single day. They pay you most of it immediately and take over your billing process, chasing slow payers and handling credit control. Your customers are aware that you are using a factoring facility but there are advantages. It is a fast and effective way of raising money on the basis of outstanding invoices owed to the company; you could have cash in the bank right away, it doesn't carry many of the risks associated with an overdraft and it is more flexible than a short term loan.
Why should I use it?
In order to produce a product, or provide a service, you also have to spend money. Without a regular cash flow, operating at full strength can be very difficult for any business. The cash flow equation is generally unevenly balanced in the favour of the customer where common business practice dictates 30 or 60 days in which to settle an invoice. Even then not all customers pay on time, and some don’t pay at all.
Cash flow problems undermine businesses, particularly small ones with little capital at their disposal, and even force them into liquidation. How much simpler running a business could be if accounts were paid almost immediately!
Is it popular?
Thousands of companies across the UK, from servicing and manufacture to distribution and transport,
raise most of their finance in this way. As long ago as 2010, The Asset Based Financiers’ Association published data which showed that British companies raised £17.9bn
by factoring their invoices in the previous year. Small to medium sized firms
find that companies offering this type of financial support can provide
a suitable substitute for an in-house finance department.
How does it work?
Once the factoring company is appointed, they will take charge of the company’s invoice book and sales ledger and collect money from customers.
The finance provider can also:
- Conduct customer credit checks;
- Operate credit control procedures;
- Assess new customers for credit worthiness;
- Provide online reporting; and
- Protection against bad debt; (although this costs money).
This is the process:
- The company issues two invoices; one to the customer; one to the
- The latter buys the invoice and pays the company up to 95% of it's value;
- They then collect the full amount from the customer;
- Once the customer pays the invoice the factors recover their outlay and pay the balance to the invoicing company;
less their business charges (which are usually a service charge plus interest).
Here's an example
- An invoice financier buys an invoice from
you worth £80,000;
- They pay you £68,000 for the invoice;
- They then collect the £80,000 from the customer, keep their £68,000, and pay
you the remaining £12,000 (less charges).
Advantages of Selling Your Invoices.
You could benefit from a number of advantages, including:
- Gaining time to spend managing the business and generating sales as a result of not having to manage invoices and chase payment;
- Having checks made on potential customers for credit worthiness, which lessens the possibilities of taking on bad debt, and increases the percentage of customers who pay invoices on or before time;
- Eliminating the risk of insolvency through bad debts; and
- An alternative cost effective solution to maintaining an in-house finance team.
In addition, having a substantial finance provider on board can increase
the confidence of your own suppliers who will know that you are more likely
to have good cash flow, and so be able to pay their invoices on time.