Factoring and Invoice Discounting

Factoring allows you to raise finance based on the value of your outstanding invoices. Growing businesses, in particular, often find that factoring is a more flexible source of working capital than overdrafts or loans.

 

Factoring also gives you the opportunity to outsource your sales ledger operations and to use more sophisticated credit-rating systems.

 

Factoring is a disclosed lending facility where your customers know that you are financing their invoices due for payment through a third party factoring company.   Invoice discounting tends to be handled directly by the customer who collects its own debts, although the invoice finance company provides you with the funding support and takes its security over the invoices, just as it does with a factoring facility. Invoice discounting helps you to keep control and confidentiality over your own sales ledger operations.

 

The advantages

 

  • You maximise your cashflow. Factoring enables you to raise up to 85 per cent or more on your outstanding invoices. An overdraft secured against invoices would only raise up to 50 per cent.
  • You negotiate an initial credit line which can grow in step with your sales. Bank finance, such as overdrafts and loans secured against existing assets, has to be continually renegotiated.
  • Using a factor can reduce the time and money you spend on debt collection. The factor will usually run your sales ledger. You retain your own sales ledger operations if you opt for invoice discounting.
  • You can use the factor’s credit control system to help assess the creditworthiness of new and existing customers. This is especially useful if you do a lot of business with companies whose turnover is lower than £6.5 million and who do not have to file full returns with Companies House.
  • You can purchase ‘non-recourse’ factoring to protect yourself against bad debts.
  • Factoring can be an efficient way to minimise the cost and risk of doing business overseas.

 

The costs

 

  • Finance charges should be comparable to an overdraft.
  • Credit management and administration charges, including the maintenance of your sales ledger, depend on your turnover, the volume of your invoices and the number of customers that you have. Typical fees range from 0.75 – 2.5 per cent of annual turnover. For invoice discounting where finance alone is provided, administration fees range from 0.2 – 0.5 per cent of annual turnover.
  • Credit protection charges (for non-recourse factoring) largely depend on the degree of risk the factor associates with your business. Typical charges range from 0.5 – 2 per cent of annual turnover.

 

The disadvantages

 

Unless carefully implemented, factoring can negatively affect the way your business operates.

 

  • The factor usually takes over the maintenance of your sales ledger. Your customers may prefer to deal with you rather than a factor.  Usually this is pre-agreed with you, so not a problem.
  • Factoring may impose constraints on the way you do business. For non-recourse factoring, most factors will want to pre-approve your customers, which may cause delays. The factor will apply credit limits to individual customers (though these should be no lower than reasonable credit control demands).
  • You may only want the finance arrangements, but unless your scale of operations is big enough to justify invoice discounting, you may feel you are paying for collection services you do not need.
  • Ending a factoring arrangement can be difficult. Your only exit route is to repurchase your sales ledger or to switch factors. On a practical level, you need to be able to provide an alternative form of financing to make up for the sudden shortfall in your working capital.
  • Only business debtor invoices can be factored usually.  Consumer invoices cannot.