Factoring provides cash to your business with no time delay issuing invoices as well as sales ledger and collective services.
For many companies outstanding invoices are their largest asset. Most companies do not have the resources and information systems to efficiently collect their outstanding invoices. Factoring can be a smart alternative to transfer the debt collection and ledger management to a factor and almost immediately get cash advances with the issuance of an invoice. The cash can be used to reduce your own debt or for investments to grow your business.
How it works
Factoring works as follows: The factor fully manages your sales ledger and provides you with credit control and collection services of all your outstanding debts. The invoices you issue upon a sale are sent to the factor who typically advances up to 80 to 90% of the invoice amount to you. The balance, less charges, is paid when the customer makes payment directly to the factor. The service is disclosed to your customer who typically receives a letter from the factor, or attached note to your invoice, containing payment instructions to the factor.
Funds are typically released to you within 24 hours of issuing the the invoice.
There are typically two costs involved: a service charge expressed as a percentage of sales factored and an interest charge for the cash advances. The service charge, covering sales ledger management, collections services, and if you wish, bad debt protection can range between 0.60% and 3.0% of turnover. The main considerations in determining the service charge are your annual turnover, number of invoices and number of customers. The interest charges calculated on the daily useage of funds is typically comparable to normal secured overdraft rates.
Choosing between Factoring and Invoice Discounting
If you business is already large enough to afford the staff and information systems to efficiently manage and collect your outstanding invoices you may want to consider an invoice discounting rather than factoring service. It is identical to factoring except that the sales ledger management – the collection responsibility – remains with you. The service is undisclosed to the customer.
Again there are two costs: An administration charge, either a flat fee or a percentage of turnover and an interest charge for the cash advances.
Rule of thumb: if your business has an annual turnover of more than £1 million and its own accounting system, you may want to look at invoice discounting.