Factoring is the provision of working capital finance for a business based on it’s sales ledger. A business would assign (effectively sell) their unpaid sales invoices to the factoring company in return for immediate cash.
Unpaid outstanding invoices have a financial value locked inside. Having sold goods or performed a service a company often has to wait a considerable time for the customer to pay. This could be any time from 30 days up to 90 days or more in some cases.
This can often put you and your business at a disadvantage. Your cash flow is threatened, since you’ve invested in the manufacturing of a product or the provision of a service. You’ve paid your staff and suppliers to make sure your client gets their product in reasonable time. And yet you only get your payment (and profit) back one or two months later. That leaves a cash gap that often has to be funded.
Factoring finance is one solution to that problem. By selling the unpaid invoices, businesses can tap into their locked in values and continue operating and growing.
How does factoring work
Factoring is a cyclical process based on individual invoices.
Step 1: The business provides a service or a product to the customer
Step 2: The business sends an invoice denoting the amount owed.
The invoice will contain a notation that it is payable to the factoring company (e.g. XYZ Factors).
Step 3: The business uploads details of the invoice to the factoring provider
Most factoring company sales ledgers are now accessed directly over the internet. You will upload details of the invoice to the sales ledger without having to send a copy to the factoring company.
Step 4: The factoring company makes an initial payment of the agreed percentage of the invoice values within the next couple of working days.
Usually, businesses receive the first payment of 70% to 95% of their original invoice values (including vat) within 48 hours. The balance is payable when the customer has paid the invoice to the factoring company.
Step 5: The factoring company administers your sales ledger and credit control
The factoring company is responsible for the administration of the sales ledger and credit control. They will chase up the customer if the invoices become overdue for payment.
Step 6: The client pays the factoring company
The customer pays the invoices to the factoring company. You then become entitled to the balance of the invoices less the factoring company’s charges.
Who can use factoring for their business
Continuously receiving payments late can result in stagnant cash flow. Businesses get crippled by large amounts of outstanding invoices which are not available for spending. This can leave your company to work on a payment to payment basis, with little possibility for improvement or growth.
Companies that lack working capital often miss out on opportunities. They range from taking prompt payment discounts to better pricing by buying in bulk.
Poor cash flow can cause potential problems in:
- Paying the staff
- Paying the utility bills and rent for the business buildings and assets
- Paying the suppliers and vendors
- Paying your business loans and mortgages
- Face interest for late payment and fear of repossession
- Keeping up with operational costs
- Maintaining in good working order your working equipment, machinery, vehicles, etc
- Invest in new tools and machinery
- Upgrade or replace deprecated equipment
- Expanding market share, reach and ultimately growth
- Optimising spending vs. gain
If you’re experiencing any of the above issues factoring may be of benefit to you. It can give you the potential to grow and become more profitable than it ever would be when strangled for cash.
Factoring is available for most types of business as long as you do the following two things:
- Sell on normal credit terms
- Your customers are businesses and not consumers
Before we point out the benefits, we feel obliged to point out some of the downsides.
The downsides of factoring
Some factoring companies offer a poor service
More so than any other type of finance, choosing the wrong factoring company can have a highly detrimental effect on your business. Not all factoring companies were created equal in terms of quality.
Factoring is a provision of funding but also has a service element attached in the form of sales ledger accounting and credit control.
If the credit control service is poor the customers will take longer to pay. Thus as the invoices are outstanding longer, you end up with a higher interest bill.
Some factoring companies have operational quirks that can limit the funding
Some factoring companies will set artificially low credit limits on your customers in order to restrict the amount of funding available and some will also restrict the funding on your major customer if the outstanding balance is too large as expressed as a percentage of the total.
Factoring is more expensive than bank overdrafts
In most circumstances factoring will cost more than a bank overdraft despite being easier to obtain. Bank loans become more and more difficult to obtain nowadays for SMEs as the banks don’t like this method of funding small businesses. As with every major expense, you will have to balance the cost of a factoring facility with it’s benefits.
The benefits of factoring
Factoring offers a set of key benefits that make it an effective alternative to traditional banking finance. Ideally, for the majority of companies the benefits should outweigh the disadvantages.
The availability of finance increases with sales.
As factoring finance is geared to sales, the availability of funding increases in line with turnover. Bank overdrafts tend to have fixed limits in line with the available security.
Factoring company handles your sales ledger and credit control
The factoring company will take over the administration of the sales ledger including credit control. This should free up management time from the drudgery of chasing up overdue debts so that you can devote more time to profitable pursuits like making sales.
Factoring is not based on your own credit standing
The factoring company’s security is the strength of the sales ledger. It is likely they will be less concerned with your balance sheet and historic profitability. A factoring company will be more interested in the creditworthiness and spread of your customers.
This is one of the reasons that factoring facilities are granted to new start companies who would be unable to obtain traditional bank borrowing.
What is a factoring broker
Factoring brokers are intermediaries acting between companies looking for factoring and the various factoring companies themselves and their role is to ensure that the client selects the most appropriate funder for their particular needs in view of the diversity of service quality as well as costs on offer
Factoring Solutions is an independent factoring broker, who operates entirely free of charge with businesses. We help you find the perfect solutions for your unique business needs. Call us now on 01827 707680 without any obligation or cost and let’s chat about factoring.