What is Factoring or Invoice Discounting ?
There are many ways to produce needed cash into a business. This can be done by obtaining or increasing an ovedraft, obtaining or increasing business loans, releasing cash tied up in debtors (the amounts owed to the company by its customers) or selling some shares.
One of the quickest ways to cope with a growing business where the high street banks are unable or unwilling to help is by releasing the money tied up in debtors.
Factoring works like this: You sell to your customer and invoice to the value of say £1,000. Normally you would wait until the end of the following month – or longer – for that customer to pay. Factoring allows you to draw up to 80% of that invoice i.e. £800 the very next day. When the customer pays the £1,000 you then get the remaining £200.
So what you are actually getting is another overdraft from a different bank which directly relates to the size of your debtor book.
Obviously this overdraft comes with costs, but these are typically the same as if your own bank afforded you the increase in your existing overdraft – in terms of overdraft interest, though the factors call the interest rate a discount charge.
The factor also charges for the administration and collection of outstanding debts and this can range from 0.5% to 2.5% depending on the values and complexity of each business.
There are many factoring companies and it is good advice to shop around and get more than one quote as each factor will have different schemes and levels of service so you can tailor the one that suits you the best – both in operations and costs.
The costs of factoring can be offset by reducing the cost a company currently has of its’ credit control department. If one or more persons are employed collecting debts then maybe a 2% charge by the factor may seem a cheaper alternative.
For example, if you have a company whose sales are half a million pounds a year then 2% of £500,000 plus VAT would equate to a factoring cost of £11,500 – less than a clerk working 40 hours per week at minimum wage.
This 2% includes sending statements and collecting outstanding sums.
In many cases bad debt insurance can also be provided and rolled into the charges, allowing companies to grow and grow knowing that they are not going to over-trade because their working capital requirement and availability grows with them.
Another by-product is that with the availability of funds which you have the option of using or not, if the discounts offered from suppliers were more than the new overdraft rate you could negotiate cheaper purchases by offering to pay quicker.
Invoice Discounting operates in a similar manner, but you the client still maintains the credit control procedure. This obviously is cheaper.
If you have a strong enough credit control procedure, and a good balance sheet there is ‘Confidential Invoice Discounting’ whereby your customers don’t have to know that you have entered into an alternative arrangement.
There are many options and in the right circumstances factoring is an excellent way of quickly raising growth finance.
Before any decisions are made it is always advisable to produce a cash flow forecast and profit and loss forecast with and without factoring to establish whether or not it is a viable option.
Talk it through with your accountant.
Don’t be led by your bank who will only recommend your banks’ factors – your accountant will have more than one contact to get the best quotes.
