Invoice Factoring is a type of business finance which releases cash currently tied up in outstanding customer invoices.
This business solution is ideal for helping fund expansion plans, improving your cashflow and collect payment from your customers. Invoice factoring is simply a way to release the money owed in funds that’s tied up in your unpaid invoices.
Instead of waiting for your customers to pay, you borrow against the money you’re owed and is a type of debt financing. Not only do you get the money you’re owed without the wait, we chase up your outstanding amounts for you with debt collection services.
What is Invoice Factoring?
Invoice factoring is a way for UK based businesses to raise money by selling invoices owed to your business to a third party factoring company at a discount. Factoring usually includes your own accounts receivable credit control, this is where the lender chases unpaid invoices up on your behalf. UK factoring companies help release cash from your debtor book. Here is everything you need to know about invoice factoring.
Invoice Factoring in the UK is where a factor or lender buys all or some of your outstanding invoices. The lender will then advance you up to 90% of their value and repays you the remaining amount, minus a commission plus interest on the advance when the accounts are settled. The amount a factor is willing to advance will depend on the standing of the debtor.
You will be granted a higher percentage on funds owed to you from a UK blue-chip company than from a sole trader. The invoice funding factor then administers your sales ledger, taking responsibility for the debts. Account statements to your client and chasing up outstanding payments will also be the responsibility of the lender. Invoice Factoring is available to any business in the UK that trades with other businesses.
How Does Factoring Work
For invoice factoring to work there must be a factor, a debtor and an unpaid invoice. The factor is the financial institution that offers or agrees to buy business debt or unpaid invoices. The debtor is the client who owes money to a business in the form of an unpaid invoice. Lastly, the invoice is the document that shows transactions between a business and its clients.
Most invoice factoring companies in the UK pay in two instalments, the first covering the bulk of the receivables. The remaining amount usually 5-10% when your client settles their invoice, minus any factoring fee. A simple process of the invoice factoring works as follows:
- You submit details of your business invoice to the factor to determine if you are eligible for the factoring facility.
- The invoice factoring company will then assess the credit scores of your clients and will then offer their quote.
- Once you agree to the terms and conditions, the factor will advance you the money.
- Collection of outstanding invoice amounts with your customers will commence.
- Once the outstanding invoice amounts has been collected, the factor will pay you the remaining balance of your money, minus their fee.
Factoring only covers business to business transactions. Each factor will have their own set of conditions that determine whether a business is eligible, so the requirements for obtaining a factoring service will vary. Specifically, qualification may depend on the company’s turnover, and requirements will vary from industry to industry.
When should your Company use Factoring?
Factoring should be used by your company when you have lots of outstanding invoices and your cash flow is suffering because of it.
An example of when you should use factoring is if your organisation sells on 30-day payment terms. You debtors normally pay within 30 days, some pay pay later and need chasing. Some of them may go over your payment terms and require a more chasing on your part. Clients that have not paid within the 30 days terms could represent a large portion of your revenue, which could be used for cashflow. The use of factoring within your company allows you to release a large part of the tied up cash almost immediately. This money could be used to:
Allow you to cover short-term expenses
Make repayments to a loan
Take advantage of business opportunities you may come across
Allows for cash flow constraints to eased..
Different types of Factoring Finance?
SMEs needs tend to vary according to growth stage and the industry it is within. If you are unsure of what type of factoring finance will suit your business, here is a brief guide to the five main debt factoring options to help you work it out:
Recourse factoring is a type of invoice factoring facility where you take all the responsibility for any unrecoverable funds. If you factor an invoice amount for £10,000 but your client defaults on the debt, then the factor is unable to collect the money owed. By using a recourse factoring arrangement, the lender would call upon the security it holds on you, meaning you would then have to repay the invoice value of £10,000 so that the lender was not carrying the loss.
In the UK Recourse factoring accounts for approximately 90% of all invoice factoring arrangements. This allows invoice factors to lend money without carrying the risk of bad debt.
This type of facility is also offered to Sole traders, contractors and start-ups. The recourse factoring facilities are still be beneficial in the sense, as they allow tied up cash to be freed for expansion, they allow you to take full advantage of your factor’s in-house credit control systems.
Its worth noting here that bad credit insurance is available which would cover any losses from none paying customers.
Non-Recourse Invoice Factoring
Non-recourse factoring arrangement, the lend will carry full responsibility for any bad debt which are suffered, this means if the invoice is unrecoverable the factor will cover your loss. With the greater emphasis being placed on bad debt insurance theses types of agreements tend to be rarer, due to the risks associated with this kind of facility the factors normally charge more for non-recourse factoring.
Selective Invoice Factoring
Selective factoring as the word suggests allows you to choose which invoices you finances this type of finance doesn’t require you to sell your whole sales ledger. It is also referred to as selective invoice discounting. Selective invoice discounting works in a similar way to spot factoring.
This type of factoring lets you keep control of your sales ledger and your client relationships. You will need to ensure you have good collections policy as you are responsible for credit control to collect the outstanding monies.
Spot factoring facilities allow you to finance a single invoice. Spot factoring is a way for businesses to fund cash flow flexibly by selling and single invoice at a discount to a third party e.g. a factor. This type of facility is also know as single invoice factoring.
The spot factoring company will be responsible for chase up the invoice from your client.
What are the Invoice Factoring Costs?
How much is invoice factoring in the UK, the associated fees and rates are entirely determined by your lender. They vary due to different factors that influence your invoice factoring providers risk of taking you on as a client. Therefore, if your business is determined to be low-risk and you have a high volume of invoices to be factored, you will generally receive lower rates.
Some lenders offer a flat fee structure, there’s a one-off, upfront fee. The length of factoring period does not affect the fee total but this usually refers to funding single invoice.
On a related note, Invoice Discounting solutions tend to be less expensive because you use a lower level of service from your provider, since you collect and manage your debts internally.
When determining your costs and fees, Invoice Factoring providers take into account the following variables:
- Invoice Volume and Size
- Customer Creditworthiness
- Business Stability
- Invoice Payment Terms
- Discount rate / Factor rate
Service fee: £10,000 x 1% = £100
Availability = 85% of £10,000 = £8,500
Discount fee (cost of borrowing): £8,500 x 4.15% (includes bank base rate) = £352.75 (annual rate) divided by 365 days = 0.966p x 30 days = £28.993
£100 + £28.99 = £128.99 to borrow £8,500 over 30 days.
Advantages and disadvantages of an invoice factoring company?
Advantages of invoice factoring:
- Get paid quicker as well as a improved cash flow and working capital
- The is no limit on borrowing, the amount lent is only tied to the number of approved invoices sent.
- Businesses can move away from more restrictive forms of finance, like secured business loans.
- Allows for planned growth and expansion due to being able to access the companies existing positive cash flow.
- Be able to focus on running your business, instead of chasing late payments.
- No need to chase outstanding payment, with factoring the lender will manage the collections process and deal with customers directly to reduce late payment and any risk of business loss.
Disadvantages of invoice factoring:
There are a number of disadvantages of using a factoring company also. Your clients will be aware that you’re using an invoice factoring service. The lender will contact them to collect the outstanding factored invoices which means that:
- The image of your company may be suffer if you client feels you are not well established enough to oversee your own credit control
- The normal standard approach to client payments communication will need to be shared with the lender
- Clients may prefer working with you directly due to customer relationships, and dislike the fact that they have to interact with your finance provider.
- Once an arrangement has been put in place, the provider will manage credit control and the collections process, customers will we aware that factoring services are being used.
It is also important to remember that most invoice factoring agreements are recourse arrangements, which means that you will be responsible for any unrecoverable invoices.
Can Any Business Use Invoice Factoring?
This type of finance works just as well for small businesses and startups, as it does for large companies. When a lender assesses eligibility, the factoring companies will look at a number of different factors, these including:
- The size of the invoice that you request payment for
- The time frame and audit journey
- Potential risks shown by your customer
- Your own companies reputation and its credit score
The latter is last of a consideration as the risk for the factor lies with the business owing the outstanding invoice. This is due to the factoring company are more interested in your customers’ credit worthiness, rather than your own.
By using Invoice factoring brand new businesses, startups and even companies with poor credit, have a means to source reliable finance more effectively. Rates may simply be slightly higher due to the hight risk due to it being a less established businesses, similar it is also the same as those with bad credit.
Is invoice factoring regulated in the UK?
No, Invoice factoring is not regulated in the UK. The industry is self regulated by a professional code of conduct by UK Finance to ensure a fair service and integrity is provided for invoice factoring services it provides.
If regulation of the invoice finance sector would to happen it is believed it would contribute to the increasing costs of its services. Due to self regulation it enables invoice factoring providers to remain competitive and provide a low-cost solution for businesses.
Is Invoice Factoring a Loan?
Factoring is not considered a loan, but a form of asset backed finance. The key point of difference with a loan is that neither part issues or secures debt as a part of the transaction.
Am I eligible for invoice factoring?
Eligibility criteria for invoice factoring differs from a standard bank loan. Each factoring company has their own requirements, but general speaking when you sell your invoices to a third party you should:
- Your business should be registered in the United Kingdom
- The business owner over the age of 18
- Your customers have a solid payment history and credit record
- A minimum volume of invoices (the minimum varies between lenders)
During the application process, it’s likely that you will also be asked for your business’ trading history, 12 months of business bank statements and related documents to give the lender a better overview of your business and whether you will be able to pay back money owed. Factoring companies will often favour businesses that are able to provide them with:
- A detailed list of their customers and clients
- Financial records for auditing purposes
- The outstanding invoices that need to be funded
- Liabilities to HMRC
Need more info
Still need questions answering, if you think your business will benefit from invoice factoring simply fill out the quick quote form towards the right of this page, or just send us an email.
Frequently asked questions
What is invoice factoring
Invoice factoring is a type of business finance that allows businesses to raise money by selling invoices to a factoring company at a discount.
How much is invoice factoring
The cost of invoice factoring is calculated by combining both the discount rate and the service fee.
Is invoice factoring regulated in the uk
Invoice finance industry is not currently regulated by the Financial Conduct Authority (FCA) in the UK. With this in mind you need to exercise due diligence with any provider you may choose, investigating the possibility of hidden fees which may not be immediately evident.
Is factoring invoices a good idea?
Factoring of invoices is a good idea for small business, compare to a business loan, invoice factoring is more flexible and can be in place within five working days.