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Invoice factoring is a method businesses can use to ensure that money is received quickly once they have completed work for their commercial customers.  It is essentially a way of raising funds to help maintain or improve cash flow levels. 

Sometimes, although various transactions might have been completed, it might take some time for an invoice to be settled after it is raised.  The business will not, therefore, immediately have the funds from these transactions to settle their own expenses or to invest in future business.  This can be a common difficulty for businesses, when debtors do not pay in a timely manner.

To help overcome such problems, invoice factoring services are available, which means that the invoice is passed to a third party that will immediately release a fixed percentage of the funds owed, as a loan to the business.  In due course, the full payment will be collected from the customer on behalf of the business. 

Once the lender, or factor receives the funds, they will then pay the outstanding balance of the invoice to the business, less their charges.  This means the business will receive slightly less money overall, but have use of it for a longer period of time.  This can be a great advantage to a business struggling with cash flow, either on an ongoing basis or as a short-term solution.

There are various different factoring companies available, with Touch Financial being the UK’s largest invoice finance broker offering access to a wide range of financing options.

Factors or debt factoring companies, as they are also sometimes known, provide financial services to businesses based on the values of the invoices that it issues for its normal goods or services.  In essence, factors are third party handlers for these invoices; they advance funds to the business based on the invoice value and then pursue payment with the customer on their own behalf, when the invoice falls due.

Factoring companies provide a range of services, including the collection of the debts and the management of business ledgers, although the individual company can retain control over how the sales ledger is managed.  Factors also supply credit insurance and other useful business support services.

Choosing a Factor

There are independent factors, as well as financial institutions and banks that offer factoring services.  Investigate several possibilities before making a decision, as services and costs will vary from one company to another.  Always check out a company’s reputation and take up any references supplied.  Using a broker is another option, this may save money as the broker receives a commission and therefore makes no charge.

Although a company may decide invoice finance offers the best solution to improving its cashflow situation it may hesitate in trusting the goodwill of its clients to an outside party. The worry is that its customers might balk at this perceived drastic change and be concerned about their supplier’s perceived financial health. Customers might also decide they do not want to have to deal with a third part when billing disputes arise. Whatever the reason, the choice of invoice discounting can make a financially sensible decision no less favourable from a customer service perspective.

Invoice discounting, unlike invoice factoring, involves the lending institution advancing between 80 and 90 percent of the value of its client company’s sales invoices, while retaining its control over billing and collections. In this way, clients need not know a business has chosen to sell its debtors list and will not experience an off-putting change in service. Invoice discounting and factoring are especially helpful for new businesses that might not yet have a solid financial history against which to borrow. By selling the invoices to the factoring company and either allowing it to handle collections or keeping the billing and collections in-house, the company ensures a constant and consistent cashflow.

The first couple of years is the make or break period for many new businesses. As a result of start up costs and juggling the demands of suppliers that want to be paid now and customers that delay payments for as long as possible, start-ups often drown in debt. By utilising invoice discounting, a company can build solid customer relationships without sinking under the weight of delayed accounts receivables.

If you have a growing business, you will know how difficult life can become if your debtors do not pay their accounts on time. You will suddenly not have enough cash in hand to pay your suppliers, which could have a negative effect on your credit standing with them. In extreme cases your business might even have to cease trading, despite the fact that it has great products and a growing customer base.

A solution to this problem could well be to try invoice factoring. There are various benefits of using this method of raising finance when compared to traditional bank financing. In the first place you will have a decision much more quickly and the money will be in your bank account within a day or two of being approved.

The factoring company buys your outstanding debtors ledger and if you choose non-recourse factoring, they will also take over all debt collection duties. If you prefer not to have someone else chase your customers for money, choose recourse factoring, in which case you have to collect the outstanding money yourself and then pay it over to the factoring company.

The cost involved will depend on the level of involvement of the factoring company, but it will usually vary between 1.5% and 3.5%.

You should note that any accounts that have queries will have to be dealt with by you, since the factoring company does not know the specifics of the agreement between you and the customer.

Despite the few disadvantages, it might well be worth your while to try invoice factoring next time your business needs a cash injection quickly.

Invoice factoring can be a useful method of obtaining finance for a company, but it is not a step to be taken lightly. Several points should be considered first, for example, what is the main attraction of factoring for your business, is it to improve cashflow problems and overcome difficulty in obtaining loans or to reduce business costs by eliminating your credit control staff? Whatever the reason, the first step is to determine the expense of billing and collecting.  Secondly, determine what monies are being lost as a result of investments not made due to delays in accounts receivables being paid. With these two bits of information, the financial officer of a company is in a position to make an intelligent choice when shopping for a factoring company.

Before comparing prices, any adverse effects of going down the invoice factoring route have to be considered. To what extend does the business rely on maintaining close customer relations? Occasionally, the introduction of a third party into the supplier client relationship can cause waves. Customers may question whether your company is in financial trouble or whether they will continue to receive the same first-class service when billing questions arise. If this might be a problem, then choose a type of invoice factoring called discount invoicing. With discount invoicing, your company maintains control over billing and collections, but still receives a substantial percentage of the accounts receivables upfront.

Once you known what can be saved and what can be gained, the search to find the best rates can begin. Remember that, as important as cost is, the quality of the factoring company is also a prime consideration. By using discount invoicing as a means of “testing the water” a business can benefit from trying invoice factoring without any repercussions and perhaps later ease into permitting the lender to take over every aspect of credit control.

One of the problems facing a newly formed company is that lending institutions are particularly hesitant to make new business loans. New businesses are notorious for closing at almost the same rate as they begin trading; they often lose money in the first few years. Once a business is established, obtaining loans is less of a problem, but until then new start-ups generally have to rely exclusively on internal funding. However, an alternative to business loans, known as invoice factoring, makes obtaining new business loans unnecessary.

Invoice factoring, also referred to as invoice or debtor finance, involves a lender, the factor, paying a percentage of the value of a company’s sales invoices upfront and collecting the debt from the company’s clients. After receiving payment, the factor then reimburses the company with whatever monies are left after deducting the upfront payment and any interest and charges.

In this way, rather than repeatedly having to apply for new loans, the company receives monies to cover its operating costs in a predictable and continuous manner, with the lender using the invoices as a form of collateral. The company has a regular cashflow and saves money on the billing and collecting of accounts receivable, because the job is taken over by the factoring company. Friction between slow-paying clients is eliminated by allowing a third party to handle collections and the company is able to concentrate its efforts on building a strong customer base, rather than spending time on credit control.

Any business looking to return capital to their account without waiting for invoices to be paid in full should utilise invoice factoring. It is not uncommon for as much as 95% of a business’s cash to be tied up in unpaid invoices. Think how much you could grow your business during the meantime if you only had that money. This is what factoring offers you. Factoring is best for businesses that need a quick turnaround of invoices to prevent capital shortages.

Competitive Rates

Since many factoring companies exist there are quite competitive rates. When you try invoice factoring, you only pay a small percentage of each invoice to the factoring company. The rest of the invoice is paid to you within just a few days.

Plan Ahead

When you don’t have to wait for customers to pay you, you are able to better plan your company’s finances. The only downside is a smaller margin of profit by using the factoring company and incurring those costs. A factor also helps you determine the credit standing of your customers so you can plan whether you should do business with them in the future or not. In the long run, you reduce the number of bad customers and increase the overall customer quality to increase cash flow.

Stay Protected

Many factors offer protection against bad debts. Even if your customers don’t pay, you still receive the agreed-upon percentage of the invoice. With a small fee each month, with is usually a percentage of the turnover, you remain protected and can maintain a regular cash flow no matter when, or if, your customers pay.

When you try invoice factoring, you increase immediate cash flow and can protect yourself from losses should customers not pay. While it may not be right for every business, many businesses find the protection and invoice management services useful and beneficial.

You have numerous options when it comes to factoring companies. In order to find the best possible factor for your business needs, there are several questions you need to ask about the factor. Considering this is a long-term relationship, choosing the right one the first time is important. You can access a full list of factors from the Asset Based Finance Association, or ABFA.  A good recommendation is what to look for.

Interaction With Customers

Check whether the factor company communicates with customers or not. Be sure you understand their procedures so you do not lose customers due to poor treatment. In addition, ask how quickly debts are typically collected. Slow collection rates could result in extra fees or even bad debts.

Interaction With Your Business

Ask how the factor interacts with your business. Factoring companies that stay in close contact with you are best. You always know where you stand and how debts are being collected. However, the two of you should agree on policies and procedures. Ensure you ask about agreement termination terms. Some require as much as a year’s notice and early termination fees can be steep.

Invoice factoring is used by businesses for a variety of reasons, but most commonly to increase working capital and improve cash flow.  It can be a useful source of funding for start-up businesses that have plenty of orders but find difficulty obtaining new business loans to fund them.  Similarly, any business with an immediate problem obtaining cash to meet its obligations might find a factoring service helpful.

Invoice factoring can also be a way of reducing administrative overheads, as the factoring company will take on responsibility for collecting payments due on the outstanding invoices.  Furthermore, the factoring company can help with credit management and, depending on the type of agreement, take on the liability for bad debts.

New business loans or other types of business loan can potentially be used instead to provide funds to support a business.  However, the business will need to be able to show that it is able to repay the loan.  Invoice factoring advances money against invoices raised for work that has already been completed and so there is less risk that the money will not be available to repay the loan.  It is therefore often easier to obtain than some other sources of finance.

For larger businesses that need more immediate access to monies from outstanding invoices, they need look no further than invoice discounting services.  Invoice discounting allows the business to borrow against unpaid invoices in much the same manner as business loans work.  This is usually best for larger businesses as the minimum annual turnover requirements are higher than invoices factoring services.

How it Benefits You

If you want to maintain control over invoices instead of sending them to a factor, invoice discounting allows you to manage your own sales ledger.  When you create invoices you notify the discounter of the details and they advance you a pre-agreed percentage of the total outstanding amount.  Typically, this amount is around 80 per cent, though the exact amount varies based upon the size of your company and its credit history.  The amount you can withdraw changes as new invoices are added.

Fees

Invoice discounting is not free.  As with business loans, you must pay interest on the borrowed amount.  You pay interest, which is much lower than with typical loans, until the customer pays the invoice in full.  You then receive the rest of the invoice amount minus the discounter’s fee.  This fee can be a set percentage of the total invoices or a regular monthly amount. 

You can save on interest by choosing a company that has access to multiple banks.  This will allow you to get the best possible interest rate so you have more funds coming back into your business.