Invoice Factoring

Factoring and invoice discounting: the basics

Factoring which is also known as debt factoring involves companies selling their invoices to a third party. In return for this they process the invoices and give you funds against the money outstanding. Basically these companies provide a debt collection, finance, and ledger management service.

Businesses commonly use this to improve cash flow but it can also be used to reduce administration overheads. Businesses that supply this service are called debt factoring companies or factors.

Invoice discounting is another way of drawing money early against your invoices. This way though your business retains control over the administration of your sales ledger. As well as providing finance it offers valuable credit insurance and support services.

This guide gives information on how factoring and invoice discounting work, different types of factoring and invoice discounting, the advantages and disadvantages, the cost and how to choose a factor or discounter.

How factoring works:

Factoring provides a fast prepayment against your sales ledger. It allows you for a price to improve cash flow and flexibly increase your working capital.

Factoring is offered to businesses trading with other businesses on credit terms. It’s not normally available to retailers or to cash traders.

When factoring starts

Factors can be independent, or subsidiaries of major banks and financial institutions. Whatever their background, they will want to meet you, visit your business, review your financial situation and study your business plan to evaluate your suitability for a factoring facility.

Credit limits might be required – if so, you must agree how they will operate.

After signing an agreement the factor will typically agree to advance up to 85 per cent of approved invoices. Payment is usually made available within 24 hours. Usually all sales go through the factor.

Check the notice period to the end of the service – most factors require three months’ notice, but some require longer. Negotiate if you are not happy with the notice period.

Factoring is a complex long-term agreement but it is advised to consult your solicitor on the legal and financial implications of factoring.

When an invoice is raised

• You raise an invoice, which has instructions to pay the factor directly and send it to the customer. Send a copy of the invoice to the factor.

• The factor makes available an agreed percentage of the invoice for you to draw as you require.

• The factor issues statements to the customer on your behalf. It operates credit control procedures including telephoning the customer if necessary.

When an invoice is paid by the customer

• The customer should pay 100 per cent of the invoice directly to the factor.

• The factor pays the balance of the invoice to you.

When an invoice is not paid

If an invoice is not paid, responsibility for paying the debt will depend on the type of agreement – either recourse factoring or non-recourse factoring.

Charges

The agreed factoring fee is taken when the invoice is received by the factor. The discount charge works like interest and is calculated against the balance of funds drawn and usually applied on a monthly basis.