Figures from the Office of National Statistics (ONS) reveal that the economy is gradually recovering. However, businesses still continue to pile up their cash reserves by trading on credit terms – structured between 30-90days. This can cause issues with cashflow.
Obtaining credit facilities from banks and other independent lenders can be an arduous process. With banks being more stringent with their lending criteria and the options given, a large number of firms have become open to broader and more flexible sources of finance such as factoring, to assist them in managing their cashflow.
What is Factoring?
Factoring is a ‘complete service’ facility which includes initial funding of up to 90% of the value of your raised invoice, as well as outsourcing credit control to the factoring provider. This form of financing is a tool that allows businesses to capitalise on the value of their unpaid accounts receivable.
Invoice factoring is a mechanism to turn a business’ outstanding invoices into immediate cash, usually within 24 hours. The remaining balance of the invoice value will be made available once the customer settles their invoice. Essentially, businesses that use factoring are focused on having most of their money now rather than all of it later.
Cashflow remains the core element to business success. Most business fail because they are short of cash, even if they have significant amounts of money owed to them by their customers. SMEs tend to have little bargaining power especially when trading with larger customers. This leaves them with no choice but to trade on very lengthy terms – structured between 30-120 days. As such, factoring can bridge the cashflow gap between raising an invoice and getting paid.
How does factoring work?
Factoring operates in the following way:
Step 1: Invoice your customers for good(s) sold or services(s) provided
Step 2: Send a copy of the invoice to the lender
Step 3: The factoring company makes available a pre-agreed percentage of the invoice value, usually 80-90%
Step 4: The credit control process – the factoring company chases and collects full payment from your customers
Step 5: The factoring company makes the remaining balance of the invoice value available, less any service charges.
Pre-eligibility criteria for Factoring
Factoring is a flexible and structured form of commercial finance that allows forms who either might not be eligible, or may not want to take out a business loan. It is suitable for your business if:
- You have an annual minimum turnover of £50000. Could vary depending on the lender
- You trade with other business
- You issue credit terms of 30-90 days
Factoring is suitable for all types of businesses – including start-up companies. It is a cost-effective solution for businesses that do not have in-house credit control and accounts functions. However, if you have an efficient in-house credit control department, it is worth looking at an invoice discounting arrangement.
The Benefits of SME Factoring
Improve cash flow
Rather than waiting 30-90 days to get paid, businesses can receive cash advances of up to 90% of the cash tied up in their sales ledger within 24 hours of raising an invoice.
Factoring offers instant cash injection, usually within 24 hours. This creates working capital for the business which might be used to cover day-to-day overheads such as payroll and operating costs, to re-invest in the business, to use as a deposit in the acquisition of assets or to reduce existing debt.
Grows with your business
With factoring, the amount of cash available grows in line with your business’ sales turnover – the more invoices you raise, the more cash is made available to you. As such, this could be a particularly attractive option for growing or seasonal businesses. There’s no need to increase your credit limit with other facilities. This is in contrast to an overdraft where you would have to renegotiate with your bank for higher credit limits.
Early supplier discounts
Factoring boosts your bargaining power and enables your business to benefit from discounts from suppliers. The funds advanced allow you to get more favourable credit terms from your suppliers with your ability to pay them earlier. This also creates an opportunity to save money as your business would’ve missed out on the offers if you didn’t have upfront cash.
With factoring, the factoring provider takes full responsibility over the credit management function – chasing your customers and collecting payments on your behalf. You are effectively outsourcing the sales ledger management to the factor, allowing you to run your business without the worry of not getting paid.
Also, the credit management function is tailored to how you intend to trade. You use the factor’s experience in assessing the creditworthiness of your customers.
Bad Debt Protection
If credit protection is of concern to you, factoring could offer bad debt protection which serves as an insurance against untimely customer defaults. This is by means of a non-recourse facility – the factoring provider bears all the risks of customer defaults. This shields your business from debtors unable to settle their invoices due to financial difficulties or insolvency.