Invoice factoring (known as factoring or debt factoring) is a financial product. Factoring enables businesses to sell unpaid invoices (accounts receivable) to a third-party factoring company (a factor).
The factoring company buys the invoices for a percentage of their total value. It then takes responsibility for collecting the invoice payments.
Invoice factoring is an increasingly popular form of alternative business funding.
This type of finance has grown in popularity as some businesses cannot use traditional finance products from high street banks. There is a list of factoring companies, should you decide to go down that route.
How does factoring work?
- Send your invoice to your client as usual.
- The business signs an agreement with a ‘factor’ who advances up to 80 per cent 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.
How much does it cost?
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. Lenders occasionally 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.
- Factoring will improve the cash flow cycle of your business quickly. This is helpful for firms usually refused traditional funding from banks.
- Outsourcing the responsibility for debt collection can save a lot of manpower and valuable staff time.
- With a factoring agreement in place, many businesses find they can negotiate better rates with suppliers. This is because they can offer more flexible payment terms.
- You won’t receive the full value of your invoice. This can be a big blow when you’re the one who has done all the work!
- Customers who have their invoice collected by a third party may lose confidence in your financial integrity. It’s not always great PR to have someone else collect money for you.
- It might be more difficult to get bank loans if invoices aren’t included as your assets. They won’t be if you’re using a third party.
Is invoice factoring a good idea for your business? Well, if we’re honest, only you can answer that. You must weigh up the pros and cons.
It’s typically a better idea for those whose profit margins are large enough to cope with the cost of the third party involvement.
If done correctly and efficiently, however, invoice factoring will simply become a normal part of the business workflow and helps manage any cash flow struggles.
If you would like to talk to us about factoring for your business, then contact us today.