Factoring has been around for a long time – around 50 years – and more than 20,000 businesses in the UK currently have a factoring facility to help finance growth.
Yet, many entrepreneurs still aren’t really sure how factoring works and whether factoring might be suitable for their own business. Here’s a brief, non-technical overview on the pros and cons of factoring.
What is factoring?
The term “factoring” is given to the oldest and still most widely used facility in a family of products now commonly referred to as “asset based finance”.
The central theme of all asset based finance products is that they release the cash that is tied up in some of your assets.
For example, you may have considerable cash tied up in unpaid invoices. Having provided the goods or service, you invoice your customer and then wait for 30, 60 or more days before the customer pays. (This can also apply to stock or any other asset, but for most SMEs, the greatest amount of cash is tied up in debtor balances.)
Put simply, factoring will typically provide around 80 per cent of the value of new invoices straight away, and the remainding balance when the customer eventually pays.
So, as your sales grow, so too does the availability of immediate cash, usually around 80 per cent, instead of waiting for your customers to pay.
Factoring provides cash in this way but also provides much more. Instead of setting up a credit control function within your business, the factor will do that for you. All you do is send them a copy of all the new invoices as and when you raise them.
In addition to the immediate cash facility, the factor will maintain a sales ledger for you, send out statements and chase up overdue debt on your behalf. In other words, you effectively outsource your credit management function.
Many factoring companies also offer credit protection against bad debts. So if a customer goes bust, it is the factoring company’s loss – not yours. They will also provide the same service for your export sales, as well as your domestic business.
Too good to be true Well let’s look at some of the pros and cons of factoring.
When is factoring NOT appropriate for your business?
- Factoring will not be available to you unless you’re selling on normal credit terms to other businesses
- The factoring company will wish to ensure that each invoice is for goods or services already provided and not part of a larger contract
- Your customers will obviously know that you have a factoring facility, and while this is a well established practise (with total UK sales volume of around £16bn in 2009), if you really don’t want your customers to be aware of this, then you might consider the sister product, invoice discounting, which is usually a confidential facility
What are some of the pros of factoring?
- No other form of finance will provide as much cash against your unpaid invoices
- As your business grows, so too does the availability of immediate cash against new invoices
- By outsourcing the collection of unpaid invoices, you can concentrate on growing your business whilst leaving the chasing to others
- Unlike bank overdrafts, factoring facilities are based on the actual purchase of the debtor balances with much less emphasis on asking for any additional security, such as personal guarantees
Kate Sharp is chief executive of the Asset Based Finance Association.