Invoice factoring explained
What is invoice factoring?
Invoice Factoring is a commercial finance product that can be used to raise money for a business using their outstanding invoices.
How does factoring work?
- You send your invoice to clients and copy in your lender. The invoice usually dictates payment to an account other than your main bank, usually a lender-controlled account that is used specifically for factoring.
- Once the invoice is paid, your lender will let you know and the remainder of the funds due to you are released.
- The lender will then release the funds to you, usually the same day or within 24 hours.
- Unlike invoice discounting, the payment is chased for you, meaning you can focus on delivering the next order, without worrying about payment.
Why do companies take out cash flow finance?
The main reason is to improve the cash flow of a business. This is due to the fact that a large proportion of each invoice is released when it is raised.
In addition to the improved cash flow position, when factoring invoices, credit control is passed on to your lender, which can save you a lot of time.
Which industries is factoring commonly used by?
Some industries often see companies run using factoring. This is due to delayed payment terms being commonplace and cash flow being key to success:
- Security firms
Of course, any company supplying on payment terms of 30 days or more can benefit, regardless of industry.
How much can I borrow?
What percentage of each invoice can I release?
The maximum tends to be 90% of each invoice, with most facilities coming in at 80-90%
How is the maximum facility calculated?
Lenders underwrite applications based on the financial strength of the borrowing business, their customers and strength of the sales ledger.
Costs of invoice factoring
The main costs can be broken down into two fees:
The service fee covers the costs of managing your facility. This fee is usually charged based on your turnover.
The factoring fee is the interest charged on the funds that you borrow. It’s charged based on the amount drawn down at any time and as such, you will save money when invoices are settled early, while it will cost more when invoices are settled late.
What are the advantages and disadvantages of invoice factoring?
As with any financial product, there are pros and cons to invoice factoring. Our expert team are on hand to help you decide whether it’s right for you but here are the main points to consider:
What are the benefits?
- Cash flow is improved by taking out factoring as funds are released immediately. As soon as the invoice is issued, funds can be released to your bank.
- By taking out a factoring facility, you have no need for a credit control team. In many cases, the cost of hiring a credit control team can far exceed the cost of invoice financing. As a result, factoring can offer you a fully managed credit control team for a fraction of the cost.
- Due to the credit control services offered by lenders, you would no longer have to spend time chasing payments. This would all be done for you, leaving you free to focus on what you do best.
- Lots of businesses accelerate growth using invoice factoring. The certainty of immediate payment means cash flow becomes far less of a worry. Often the funds released early can be put to good use to help the business.
- Negotiate improved terms with suppliers due to your new-found ability to make prompt payments. Improved cash flow can be put to good use for this purpose amongst other things. The benefit in this area alone can often more than cover the cost of the facility.
And the drawbacks?
- Your customers will know that you’re using this method of funding, which may not be ideal for some business owners.
- You lose control of outstanding debts, meaning you can’t manage a relationship with your customer if they are late paying. This is actually seen as a benefit by some business owners, however, as it means they can’t be leaned on by clients to accept late payments.
How to get your application approved
Who offers invoice factoring?
The landscape in the market is made up of high street banks, challenger banks, specialist invoice finance providers and peer to peer lenders.
High street banks and some of the specialist invoice finance providers tend to offer the most competitive terms. Challenger banks position themselves to take on quirkier applications, such as those with poor credit, weaker sales ledgers and previous failed companies.
Should I use a broker?
The factoring market can be tricky to navigate, with likely terms not usually presented online. As such, a broker can be a great tool to help you secure the best terms for your business.
Most brokers don’t charge a fee when arranging invoice finance, instead taking a commission from the lender once your facility is set up.
Whether you choose to work with a broker ultimately comes down to personal preference.
Is it invoice factoring regulated in the UK?
This market is not regulated by the Financial Conduct Authority (FCA).
As such, you do not have the same consumer protections in place that you would have with a residential mortgage or other regulated finance agreement. This means that careful consideration must be taken when considering a new agreement.
Hidden fees and penalties tend to be the biggest areas of concern, although of course, the full agreement must be thoroughly checked.
The closest thing to a governing body is the Asset Based Finance Association (ABFA), which is a voluntary trade organisation.
If regulation is a key consideration for you, we can focus our search for funding around banks, which are always expected to follow FCA guidelines on treating customers fairly.
Is invoice factoring suitable for my business?
Yes, it is suitable for any B2B businesses that would benefit from improved cash flow. If delayed payments from creditors hold back your ability to efficiently run or grow your business, this could help.
By receiving payment almost as soon as the invoice is raised, everything from payroll to paying suppliers and managing growth becomes simple. The revolving funding line is designed to grow with your business and is naturally in tune with your busy periods.
When compared to other types of invoice finance and business funding options such as overdrafts, business loans and peer to peer lending, invoice finance is often the most flexible option. By transferring credit control to your lender, the benefit can easily outweigh the cost. The time saved worrying about chasing payments can now be spent on running your business.
Do I have to factor every invoice?
When using this type of finance providers fund every invoice raised. Therefore, taking a high level of control of your debtor book. This tends to work well for companies in need of regular cash flow support.
Where you’re looking to fund a single invoice, or selective fund invoices on an ad-hoc basis, you should consider selective invoice discounting.
Is factoring a type of loan?
Factoring isn’t considered a loan, as you’re not actually creating a liability. Instead you’re taking an advance on money that is owed to you.
Business loans are actually handled very differently, with funds released as a lump sum and repayable over a set term.
Do you offer bad debt protection and other add-ons?
Bad debt protection can be added to your factoring facility. It is designed to ensure that you receive payment even if your customer is unable to settle the invoice. Our lenders are able to offer full protection against bad debt, meaning you no longer have to worry about companies failing to pay.
In the event of customer insolvency, the whole process is managed on your behalf, meaning you don’t have to spend time negotiating with liquidators. This can save significant amounts of time and stress.
Bad debt protection and other add-ons increase the cost of your facility.