Invoice factoring: pros and cons

 

With recession making cash tighter, invoice factoring and discounting is on the rise in the UK. But many businesses are still wary about the practice. 

This article explores the cultural resistance to factoring, as well as some of the benefits and risks as perceived by AccountingWEB members.

What is factoring?

As our Guide to Alternative Finance 2012 explained, invoice factoring and discounting involves selling sales invoices to a finance provider, who pays a fixed percentage of the invoice in advance. When the invoice is paid, the finance provider pays the balance to the seller, minus their interest and administration costs.

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  • What is factoring?
  • The rise of factoring
  • What are the benefits of factoring?
  • What are the risks of factoring?

Continued...

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Comments

Factoring- Pros and cons

roundwindow | | Permalink

As a consultant in the industry here in the UK, in Europe and Asia and who has worked with the sector for over twenty five years, I thought I might share a few of my observations... especially with those who continue to feel that factoring is not for successful businesses…

Factoring provides working capital for growth. It is ideal for “sell and forget” product and service providers and for those who may have little to offer traditional lenders by way of track record, assets or retained earnings.

This description often fits SMEs. By their entrepreneurial nature SMEs have a high probability of failing within 1-3 years of start up. So some SME failures will indeed have been factoring. Some will have had overdrafts. Some will have had loans. Some will have had leases. No causal relationship.

If a company is going to fail, factoring cannot save it. It is not a panacea. But the cash support it can provide might buy enough time for the management to address the underlying issues.

Getting out of factoring is like getting out of an overdraft. If you are profitable and cash generative, over time you will have less need for external funding and can withdraw if you wish. Until then you can also change supplier, you can swap factoring for loan/ overdraft (if you have the collateral). Yes, suppliers seek minimum contract periods to cover costs. That's where negotiation comes in!

Over forty thousand businesses in the UK use this funding; globally it’s approaching 500k. It clearly is serving a useful business function. But it won’t suit all businesses; for example, for those with complex contracts it probably will not be ideal.

If it wasn’t fulfilling a valuable and cost effective role, then like any other industry it would not survive. It would not be handling approaching 220Bn of turnover and advancing £16Bn of funds in the UK.

There is a lot of competition for business here. This leads to competitive pricing and a strong desire to retain business through service. Get quotations to show how much it really costs. Compare those to other forms of funding; overdrafts and loans are not free! (And remember that the cost of factoring may be partially offset by acquiring early payment discounts from creditors.)

Factoring, invoice discounting, asset based lending, reverse factoring, import and export finance are all part of a spectrum of sources of essential business support available from the Industry providers. One or a number may be suitable for a business depending on its particular environment and needs.

These services are also increasingly being used by medium and large scale corporates as the flexibility and value they can provide is also being better recognised by informed and sophisticated users.

The global market in 2011 was approaching 2 trillion Euros in turnover, a significant mechanism for sourcing working capital funding in both developed and emerging markets.

If you want to know more, please get in touch.

John Brehcist

john@roundwindow.net