In this troubling economic climate, banks have become increasingly reluctant to offer credit facilities as their lending criteria have become more and more rigid. As a result, businesses have had to shop around for other forms of finance.
Many regard factoring as a flexible alternative to the bank overdraft, but however, both facilities provide the basic necessity – cash. Factoring.uk.net presents a few facts to consider when applying for either form of finance:
Factoring is a form of invoice finance where a factoring provider (could be a bank) releases a pre-arranged cash advance against a business’ sales ledger. The process also includes an outsourced credit control, where the factoring provider manages the business’ customers and collects payments. The remainder of the sales ledger balance is paid to the business once their customer settles their invoice. Hence, factoring involves three parties: the provider, the business and its customers.
Bank overdraft is an arrangement where the bank allows a business to continue to withdraw money, up till a set limit, even if the account has no funds in it. Simply put, it is an extension of credit from a bank when an account reaches zero.
A bank overdraft is an authorised funding limit and as the business grows, the limit will have to be renegotiated with the bank. The size of the overdraft is linked to the capital in the business. On the other hand, factoring can release up to 95% of the value of unpaid invoices, usually within 24 hours, once the invoices are raised. Factoring is linked to a business’ sales ledger activity (not the balance sheet) and will therefore grow with the business
Banks will often insist on property or machinery as the only acceptable security on an overdraft. Moreover, the bank reserves the right to demand that the overdraft be repaid at any time – occurs when the user breaches the terms of the contract. Factoring arrangements are secured on the business’ sales ledger and typically require no personal guarantee.
To obtain an overdraft, a business has to adhere to the strict criteria put forward by the bank. Overdrafts are suitable for established businesses with excellent credit scores and trading history. Invoice factoring, on the other hand, is an attractive option for any business that sells on credit to other businesses, with a £50k and above turnover. Loss-making, start-ups and regional firms could qualify for factoring.
Overdrafts typically have two fees: arrangement fee, which is a charge for setting up the facility and an interest charged on the amount overdrawn – could be a fixed or variable charge. In the same way, factoring has two principal fees: service fee, which is a charge of administering the facility and a discounting charge on the amount borrowed. Usually, most factoring providers offer an all inclusive fee for the facility.
An overdraft is written off as an expense to the business and the cost could sky-rocket if a business overdraws above the funding limit or defaults on payment terms. Factoring can be a cost-effective and convenient funding solution as the facility is simply a cash advance against unpaid debt and does not increase balance sheet liabilities.
Factoring is thus a flexible and realistic alternative to the conventional overdraft. Whether factoring is the right solution for a business depends on the firm’s current situation and needs. It is important that a business chooses the right factoring provider to attain competitive advantage and to safeguard the survival of the business.
This is a guest post by Sema Fongod from Factoring.uk.net, the factoring and invoice discounting experts.