A Brief Description of Factoring Factoring can be described as the provision of or the making available of finance against the security of trade debts. Additionally factoring provides a sales ledger and credit control service with if required bad debt protection.
Factoring is only suitable to companies who are trading business to business and who offer goods or services on credit terms. By providing upto 85% finance against invoices factoring can bridge the gap between the raising of an invoice and getting that invoice paid. Therefore it can be of tremendous benefit to an expanding business in providing sufficient working capital to meets its cashflow requirements.
More and more factoring is seen as an alternative to the traditional bank overdraft with the added benefit in that it does not need to be constantly reviewed as set limits are breached as can happen with an overdraft. Instead it is expressed as a percentage of the value of outstanding invoices – so as more invoices are raised more funding can be made available to the business.
How does it Work?
As an invoice is raised it is assigned to the factoring company. The original is sent to the customer in the normal way and a copy is sent to the factoring company as notification. On acceptance of the invoice the factor will make available an agreed percentage of the value of the invoice, which can be taken as and when required. Depending on the type of arrangement entered into the factor would then be responsible for entering the invoice into a customer account within the factor’s sales ledger, sending periodical statements of account to the customer and collecting payment for that invoice as if falls due for payment. As the initial payment is at an agreed percentage (not normally more than 85% of the value of the invoice) the remaining sum will become due to your business either when your customer pays the factor or at an agreed maturity date.
Types of Factoring Facility
a) Confidential Invoice Discounting
This is the provision of finance against the security of trade debts of upto 85% of the value of the sales ledger. With this facility the customer is unaware of the arrangement as no disclosure is made and you continue to have the responsibility of collecting payments on behalf of the factor and paying these monies into the factor’s bank account.
b) Disclosed Invoice Discounting
Sometimes referred to as ‘Agency Factoring’, operates as above but with notification of the arrangement being made to the debtor by way of an assignment clause printed on the invoice. As this gives the factor greater security than a) above there is more flexibility to the factor in deciding the level of funding it can provide.
c) Recourse Factoring
As b) above but with the factor responsible for the administration of the sales ledger and the chasing of overdue accounts for payment. This is the most common form of factoring arrangements and by outsourcing this function it can free-up valuable management time allowing the prime movers to concentrate on the development of their business. The word ‘recourse’ means that if the customer fails to pay the invoice after a set period of time the factor will require any funding provided against that invoice to be repaid by its client – normally recovered from later invoices.
d) Non-Recourse Factoring
As c) above but with the factor also providing bad debt protection. This is normally based on limits set by the factor per customer dependent on the credit worthiness of that customer.
e) Maturity Factoring
Maturity factoring works on the basis of the factor guaranteeing to make full payment of an invoice after a set number of days from the date of the invoice regardless of whether the customer has paid or not. The main benefit of this type of facility is in cashflow planning, as you will know exactly when you are going to be paid.
f) International Factoring
Some factoring companies offer an international facility for the collection of debts abroad. They will make use of an associated factoring company based in the respective country of your customers who will be responsible for the collection of payment which they will remit back to the UK based factor.
Effectiveness of Factoring - How can it Help Your Business?
The most effective use of factoring is as a source of finance in a time of expansion by releasing working capital tied-up in trade debtors. Not only does it do this by providing cash in advance of the customer paying it can also ensure that debts are paid in a timely manner which will also improve your cashflow.
The other major benefit is that it can release valuable management time in administering of the sales ledger allowing prime movers to concentrate on the development and growth of their business.
Costs
There are two main costs in factoring which are briefly explained below:
Administration Charge - this is a factoring fee for the administration of the sales ledger and is expressed as a percentage of the invoice value. This varies depending on the workload to the factor but is normally between 0.5% and 1.5%.
Discount Charge - this is the cost of money advanced against the sales ledger and works like Interest in that it is charged as a percentage above Bank Base Rate and is normally no more expensive than an overdraft facility.
