Invoice factoring can take the worry of cash flow but beware the pitfalls too.
What is invoice factoring?
Invoice factoring is a process to release up to 95% of your invoice value immediately to boost your cash flow while letting a factoring company collect the debt incurred.
Factoring is not for everyone because it means it’s not you who is talking to your customers and some factoring companies may chase the debt more aggressively than you’d prefer.
How does it work?
Businesses sell on their invoices to a debt collection company who will collect sales invoices on the client’s behalf. Most companies use factoring to improve cash flow but it also removes the administrative process of managing an accounts department, plus the inconvenience of companies not paying invoices within due date.
Many companies offer factoring services, including the major banks who will have a subsidiary company. However, those considering going down this route should be aware that factoring is a long-term and legally-binding commitment; check all agreements thoroughly before signing anything.
The good news is that you are likely to receive up to 95% of the invoice value within 24 hours of passing the debt to the factoring company. Your customer then pays the factoring agency and the agency passes over the balance to you, minus their fees and any applicable interest.
What does factoring cost?
Rather than charging interest and arrangement fees like a bank loan, factoring fees are split into two parts:
- A service fee covers the day-to-day servicing of your purchase ledger. This can be between 0.5% and 3% of your turnover.
- Interest is charged against the amount of each invoice, usually at a fixed percent above the factoring.
When should I consider factoring?
Certain sectors are better suited to factoring than others – especially those sectors where the principal asset is intangible, e.g. services, and there are no other assets such as buildings, plant or machinery to raise money against.
Typically but not exclusively, factoring tends to be used by smaller businesses that are unlikely to have their own in-house credit departments.
Not every business can benefit from invoice factoring. Small businesses where the principal asset is an invoice and there are no other assets to raise money against, with a minimum turnover of £50,000 minimum, are suitable to use the process.