Guide to Factoring
Around 10,000 UK businesses go to the wall each year because cash they are owed is paid too late. One way of plugging the hole in cashflow while you await payment is factoring.
Put simply, factoring provides cash to your business by allowing you to raise money from the unpaid invoices owed to you.
For many companies, outstanding invoices are the largest asset on their balance sheet, with up to one quarter of a company’s annual turnover remaining unpaid at any one time. This ‘locked up’ cash can greatly affect the growth potential of a company.
In addition, most smaller businesses do not have the resources to collect their outstanding invoices efficiently. Transferring the debt collection to a factor is an easy way to give your cashflow a shot in the arm. A bonus is that customers may pay up more readily to a factor.
How it works
Factoring is straightforward:
You perform services or deliver goods to your client; you notify the factor of the work performed and an invoice is raised; the factor advances you the pre-agreed percentage value of the invoice the next day; the factor collects outstanding debt; the factor takes its fees and then pays you the balance of the invoice value.
Factoring charges are made up of a service fee, often expressed as a percentage of the total volume of invoices factored (this ranges from 0.5-4%); and an interest charge applied on the money lent to you by the factor.
To trade with complete confidence, businesses can take out credit protection, so that even if they suffer a bad debt they will be paid.
Agreed credit limits will be required.
Far from being an expensive luxury, the cost of using a factor compares favourably with other sources of finance, such as overdrafts.
It pays to shop around
Your factor's terms and conditions will vary. This is one reason why it pays to shop around when choosing one.
The factor will need to check your books and accounts to ensure that your systems and sales ledger meets its criteria. It has the right to ask you to change the way you run these systems. Factors may also want to have a say in how you conduct your business.
Who can use factoring?
Factoring is not suitable for businesses that mainly sell direct to the public, such as retail shops. Annual turnover should be more than around £250,000 and you should have a reasonably large client base.
How to find a factor
Factoring services are provided by specialist companies, which are often subsidiaries of banks.
Useful links
Factors and Discounters Association http://www.factors.org.uk
