Factor in the Factoring

Factor in the Factoring

Image copyright of selectfactoring.co.uk

With any small business one of the most difficult things to learn is how to manage cash flow. Most business courses and books harp on about it - quite rightly - but sometimes even with your best efforts the cash flow for your business just doesn't function the way you would want.

There are a number of interim solutions for cash flow issues you might face but this post is specifically about the use of Factoring to help make those cash flow issues a little less profound.

What is Factoring?

Factoring is effectively the selling of an outstanding invoice to a financial company at a  discount.

The three parties directly involved are:

- The seller (one who sells the invoice)

- The debtor (customer of the seller)

- The factor (financial organisation)

In invoice factoring, the factor provides financing to the seller of the accounts in the form of a cash “advance,” often 70-80% of the invoice face values, with the balance of the purchase price being paid, net of the factor’s discount fee (commission) and other charges, upon collection. The emphasis is on the value of the invoice which is essentially a financial asset. The seller is borrowing against its debtors.

So an example would be:

You are the seller and your client owes you £10,000. You're cash flow means that you need money quicker than the invoice will be paid.

You go to the Factor and sell the £10,000 for £9,000. You therefore have 90% of the invoice value to help your cash flow.

When the invoice is paid by your client, the full £10,000 goes to the Factor - thereby they make £1000 for extending you the £9000.

What's the downside of Factoring?

The real downside is that this is an expensive way of managing your cash flow. Its not a strategy that will help your business in the long term but for a short term requirement its often a quick and easy way to address any issues your business is suffering.

How does this effect my clients?

In theory not at all but not all clients are created equal. Sometimes your business is not the issue and your clients are:

- Customers with a higher than average credit risk and don't pay on   time
- There are service related problems with queries, disputes,      complaints
- They are not you and don't chase debts in the early stages as you   would i.e. deal with service issues or use your trading history    and customer relationship.

What this means is that although your business is acceptable for the Factor your clients might not be and therefore their invoices can't be used in the factoring.

How do you find a Factor?

The best place to start is with your existing bank. Most large banks have a factoring company that they either own or partner with. Because of the existing relationship then its likely this is the route of least resistance in terms of getting some invoices factored. A Factor that has no previous knowledge or relationship with you and your business will need to do some due diligence to understand how your business works ahead of agreeing anything with you.