Debt Factoring is a finance product that allows business to receive an advance on unpaid invoices from their customers.
The good news is that debt factoring could be an accessible and affordable option. Waiting for clients to pay their invoices can be frustrating and, despite attempts from governments to improve the situation, it’s getting worse.
Indeed, many of the businesses which fail over the next year will do so despite otherwise being in a healthy financial position.
However, there could be a solution in the form of debt factoring. Debt Factoring is simply an alternative term used for Invoice Factoring in the UK.
What is debt factoring?
Debt factoring is is a finance facility for companies, it allows unpaid invoices to be used as collateral for a loan. The business will be given up to 90% of the invoice value almost immediately from the point of raising the invoice, therefore reducing the cash deficit for the small business.
Debt factoring is proven to help businesses grow and prosper and is an excellent alternative to a bank overdraft.
A quick definition of debt factoring is when a business selling their invoices to a third party at a discounted price in order to bypass the hefty waiting times which are associated with invoice payments.
It has become especially popular with SMEs due to its ability to provide them with instant access to capital and speed up their processes.
Types of debt factoring
The two types of debt factoring that are using are known as recourse and non-recourse. With recourse factoring, you remain liable for payment of the invoice.
This means if your customer does not pay after a specified period, you must pay back the advance and the factoring company’s fee. This is why most lenders will ask if you require credit insurance, this will have to be paid at your own cost.
By using non-recourse factoring, the risk of non-payment passes to the factor. If the customer does not pay, you keep the cash advance and the factor takes the loss.
By using none recourse you can expect to pay a higher fee for this type of debt factoring. It time it takes to arrange a facility is also longer as the factor will credit check your customers to make sure that the invoices you’re factoring stand a good chance of being paid on time.
How does debt factoring work?
There are three parts to make debt factoring work, there’s are: a business, a client, a debt factoring company.
- The Business could be any type of company that sells goods or services, the company does need to trade with their customers on credit terms.
- The client is the entity, this also needs to be another business who bought the product or receives the service and is responsible for making the payment for goods or services.
- The debt factoring company is the party who buys the original invoice from the business and collects the payment from the client when the invoice is due.
Within 24 hours after the debt factoring company buys the invoice, it will pay the business a percentage of the invoice amount due by the client. Once the debt factoring company collects the full payment from the client, it releases the remaining percentage of the original invoice amount due by the client, minus a factoring fee.
Debt factoring advantages and disadvantages
There are a number of advantages and disadvantage to debt factoring, we have lists a few below:
Advantages of debt factoring:
- Overcoming short-term cash flow problems: If late invoice payments are causing you financial problems, this can be a quick and affordable solution. You’ll have the majority of the money owed to you in your account in time to make all your payments. This can help you avoid paying your own suppliers late and damaging your credit score.
- Reducing stress: Late payments of invoices can be immensely stressful for business owners. As such, this can be great for your own peace of mind and help you to sleep more comfortably at night.
- No impact on your credit score: Unlike a loan this will not have an impact on your credit score. That’s because this is an advance on money which is already owed to you.
- Bad Credit? No problem: If you have bad credit, securing a loan can be more difficult, but a debt factoring company will not take as much notice of your credit score. Although they will take it into account when setting their fees, it is not your credit rating they are worried about as much as the chances of your invoices being paid.
- Reduced admin: As part of the service, they assume responsibility for chasing the invoices. This reduces the administrative burden on you and your team and frees you up for other things.
Disadvantages of debt factoring:
- The business must have a turnover or expect a turnover of at least £75,000.
- The customer spread must be good good.
- Customer base must be at least three clients.
- The business must offer sales terms on its goods or services.
Those companies wishing to access a debt factoring facility will need to consider whether they fulfil the following qualification criteria:
- Must have a turnover of at least £75,000 per year.
- Funders will only arrange facilities for businesses operating in the UK.
- You’ll also need to ensure that the credit terms offered to your customers when raising invoices span from 30 to 90 days.
How does debt factoring improve cash flow
Debt factoring improves cash flow by reassessing funds in unpaid invoices. Once an invoice has been issued to your customer that money is available to be used as working capital.
With this in mind, it means you never have to wait the full term of your invoices paid. This type of finance is important, because waiting 30, 60 or 90 days to be paid can put a severe strain on your business.
That’s not surprising, given the average time taken to pay invoices by UK businesses is 45 days. Sadly, the average time it takes larger businesses to pay small businesses is even worse. So this is why debt factoring can improve your cash flow almost immediately.
It will allow funds to be available for you to deploy to:
- pay your bills and business expenses (e.g. wages, rentals, tax and insurances)
- buy supplies or equipment
- grow your business… without that extended wait.
Which industries favour debt factoring
Any business which invoices another business with credit terms of 30-90 days would be a typical candidate for debt factoring. Equally, a business which has a smaller number of clients owing a higher value of invoice means there is a particular cash-flow vulnerability to late payments.
Certain industries tend to utilise some sort of invoice finance facilities more than others:
Apply of a Factoring Facility
To apply for a debt factoring facility is it simple. Invoice Funding are one of the UK’s leading Factoring Brokers. If you feel that factoring can support your companies cash flow and growth plans, simply complete the online enquiry.