Invoice Factoring – the new overdraft?

Invoice Factoring – what is it?

Invoice Factoring is very simple.

You enter into an agreement with a finance company, usually a bank or a specialist factoring company, such that every time you invoice a customer the finance company give you a percentage of the value up front, typically 70% to 90%.

They then take responsibility for collecting the debt from your customer and when they do so, they pay you the balance – less a fee of course.

This means that you can improve cashflow considerably.

If you are a growing company,  you will need more working capital and Invoice Factoring could be a good solution, since your available advance grows with you.

You can factor both domestic and export invoices.

Factoring companies like to see a good spread in your customer base with no dominant customers.  If you have a dominant customer, they may impose some restrictions.

Invoice Factoring is not the cheapest form of loan, but it is substantially unsecured and  available to most companies without too many hoops to jump through.

What does it cost?

Each case is different, so costs can vary considerably.  We list below the charges you will incur and a “typical” cost:

Set-up fee:  This is a one-off charge and likely to be anything from £500 to £2,000.

Management fee: This is usually a percentage of your invoices and varies between 0.5% to 3%.  The bigger your turnover, the lower the fee.  There is usually a minimum charge, which can be imposed monthly or quarterly.

Interest: If you take an advance, you will likely pay between 1% to 4.5% above LIBOR in interest charges.

Other costs: Factoring companies also make charges if things start to go legal with your bad debts and under some other circumstances.  Normally the total of these charges is trivial in comparison to the main fees above.

Security: You will probably be asked to give a Personal Guarantee for a small amount, typically £5,000, but the main security is the charge over your debtors held by the finance company.

As a percentage of turnover at the low end it will be 2% and at the high end as much as 10%

If you are looking for a factoring company, the first thing to do is shop around.  There are over 50 companies offering factoring facilities and they vary considerably. Not all will be interested in any particular deal and some specialise in certain sectors.

Their contract can seem a bit daunting at first, but when you break it down, it’s not too difficult to grasp.

Key things to look for

Term: Most factoring companies are reasonable about the termination period, but always check.  The banks will often ask for an initial 12 months period, followed by 6 months termination – this amounts to a minimum of 18 months initially.  You should be able to get a 6 month term.  One major bank even offers a rolling monthly termination from day one.

Interest: Try to get no more than 2% above LIBOR.

Minimum charge: This will depend on the expected volume of transactions – but negotiate a quarterly or even annual minimum.  If you have a MONTHLY minimum, in a month you don’t do much, you will get charged for the minimum and you won’t get it back!

Management fee: Anything in over 1.5% is excessive, unless your debtor profile is high risk or requires lots of work for the factors.

Other points

One-off cash boost: Factoring gives you a cash boost once, equal to about 75% of your current debtors.  So if your turnover is £600,000 pa and your average outstanding debt is 60 days (2 months) then your outstanding debt at any point will be around £100,000.

Factoring would give you around a £75,000 cash injection and then you would get your future invoices paid 75% up-front.

This would be a handy sum to invest in growing the business and as growth occurred, getting bills paid up-front would continue to aid growth.

Customer resistance: Some companies are somehow embarrassed by factoring and argue that their customers don’t like it.  This is nonsense.  Most companies will already have several suppliers who use factoring; perhaps they feel they can manipulate you more than they can a finance company…

If it really is a problem, you can still fund your invoices – but it’s called Invoice Discounting.  The technical difference is that you fund the invoices without your customer knowing – but you have to do the credit control, debt chasing yourself.

Bad debt protection: For and additional fee (of course) the finance company will offer you protection against bad debts.  They will be responsible for collection and if the customer fails to pay, they will accept the loss.

This is usually called “non-recourse” factoring, since if the customer fails to pay, there is no recourse to you.

Debt collection:  Factoring companies will often only chase your top 5-10 debtors by default.  Check out the credit controls they are offering and remember the finance company makes money from YOU the longer the debt is outstanding.

Author: David Saul, Director, support2business Ltd. 0871 218 2218