Put simply, factoring allows you to sell the debt you are owed to a third party, which pays you a portion of the debt you are owed in advance of collecting the full amount. Below are the basics of factoring and invoice finance.
How to avoid debt trouble
The best ways to avoid the problem are to agree payment terms in advance, ensure invoices are clear and have adequate credit control procedures.
But many businesses need external expertise when it comes to turning orders into cash. This is when a factoring service can help.
The term 'factoring' describes a range of complementary, sales-linked financial services that can be tailored to individual business needs.
The main advantage of outsourcing debt is that it is an easy way to give your cashflow a shot in the arm. It can also help ensure you spend less time on credit control. An added bonus is that customers may pay up more readily to a factor.
On the downside, factoring may reduce the amount of money you can borrow from your bank, as the book debts will not be available as security. Also, factors may want to have a say in how you conduct your business.
How it works
The mechanics are quite straightforward. As soon as goods are delivered or services completed, the business produces an invoice. At the same time, a copy of the invoice is issued to the factor. From that point on, the factor takes responsibility for chasing payment and paying the business up to 80% of the value of the invoice up front. Once the factor has received payment, the balance becomes available to the supplier.
Using a factor allows a business to have access to cash that would normally be tied up in credit for months, and frees time to concentrate on service and sales.
The small print
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.
Agreed credit limits will be required, then an agreement will be signed. Typically the factor will agree to advance 80%-85% of approved invoices. Payment is usually made within 24 hours.
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, sometimes known as factors, which are often subsidiaries of banks. HSBC Invoice Finance (UK), for example, is the specialist cashflow services arm of HSBC Bank.
By Martin Huckle