What is a Factoring Company?

what is a factoring companyA factoring company helps businesses that are suffering from late paying customers and incurring cash flow problems as a result then this type of lender maybe able to help.

They offer an alternative type of borrowing known as invoice finance to businesses that trade with other businesses and requires a non debt solution to their cash flow problems.

The factoring company will buy unpaid invoices from a business for a fee and the invoice is paid on a term basis to the factoring company. Factors will buy invoices from businesses that require funding to help with cash flow, in return the business will receive around 90% of the invoices value in cash immediately.

Once the full amount of the invoice is paid by your customer to the factoring company, your business will receive the rest of its value minus the factors fee.

What does a factoring company do?

Factoring companies specialise in invoice factoring, the provide working capital to B2B trading style of businesses with working capital. Factors offer startups to multi nations with funding to allow them to grow or trade out of a shortage of cash within their businesses.

By realising working capital the business to access cash flow immediately after issuing an invoice. This is a clear advantage as it removes the need to wait 30-90 days for the customer to pay.

Once a factor has purchased a business’s invoices, they collect directly from the business’s customers by the use of their own credit collections team.

How does a factoring company work?

A factoring company works by provides businesses with funding by purchasing their receivables at a discount. This allows businesses to get the money they are owed immediately, rather than waiting for customers to pay.

Factoring companies typically charge a fee for their services, which is based on the amount of money being advanced and the length of time it takes for the receivable to be paid. In some cases, businesses may also be responsible for paying a percentage of the invoice if it is not paid on time.

By using a factoring company, businesses can improve their cash flow and keep their operations running smoothly.

How does a factoring company make money?

A factoring company will make money by purchasing a businesses invoices for a discount. The then collect the full amount from your client, this difference between discount and what is paid by your client is the factoring company’s profit.

The also add a number of other costs and fees to make their money, these include monthly minimums, renewal fees, CHAPS payments.

Who pays the factoring company?

Customers

The factoring company will pay you typically up to 80-90% of the value of the invoiced amount immediately, subject to verifying that the invoices are valid. Once the invoice becomes due, your customers pay the factoring company directly. The factoring company chases invoice payment if necessary.

Difference between a factoring company and traditional lender?

Factoring is not a loan, it is purchasing an asset e.g. the invoice from your business. As you are selling an asset you are not incurring debt as a result this does not effect your businesses credit report.

Trading lenders you are tied into how much you can borrow and is fixed for a period of time with a fixed repayment schedual.

How do factoring companies calculate their fees?

Factoring fees & rates are generally range from 1-5% and are calculated based on a number of elements:

The Amount of Money Being Factored:

Like any business the economies of scale are at play for factoring companies as well, meaning to more you borrow the cheaper it is. The factor will absorb most of the fixed costs associated with establishing and maintaining a factoring relationship at the start of the agreement.

Length of Your Invoice Terms:

The longer your payments terms are with your customer (i.e. 60 – 90 days) the higher rates the factoring company will charge. This is due to cash being advanced to your business for a longer period of time. At this stage the finance works like an overdraft, once you take the cash the clock starts to tick.

Credit Rating and Quality of Your Customers

Due to the nature of how factoring works, the risk is placed on your customers. The factoring company will want to ensure that your customers are of good standing and have a good credit rating in order to get a credit line on the business. Better the credit score of your customer will result in lower factoring fees and a larger credit line.

Advantages and disadvantages of working with a factoring company?

There are a number of advantages and disadvantages of working with a factoring company:

Advantages of working with a factoring company

  • It can improved and shortened cash flow cycle
  • Knowledge that your invoices will be paid quickly
  • Quick and easy way of obtaining finance
  • No need for collateral or security
  • There is no debt incurred as factoring is a sale not a loan
  • Free credit checks on your clients to ensure they are credit worthy

Disadvantages of working with a factoring company

  • There will be a slight reduction in profit as there is a fee incurred on the value of the invoices
  • The amount that can be advanced from invoices is dependent on the credit worthiness of the customer
  • Possible recourse liability for unpaid invoices
  • The factoring company will contact your customers for payment of invoice
  • Can work out more expensive than other forms of finance

How to choose a factoring company?

When it comes to choosing a factoring company, there are no two factoring companies the same. All the companies offer something different within their niche and a number of factoring companies specialise in different industries, as well as offering different terms, and rates. With the number of different factors it makes comparing factoring companies difficult.

These are the five questions to ask:

    1. How long have they been in business?
    2. What are their terms, fees, funding limits, termination fees?
    3. Frequency and speed will your invoices be funded and payments applied?
    4. How do they interact with your customers?
    5. Who funds them? are they bank funded, private investors?

Are factoring companies regulated?

No, factoring companies are not regulated within the UK. There has been talk about them being regulated by the FCA (Financial Conduct Authority) but as of 2022 they are currently self regulated.

Do I need a factoring company near me?

There is no need to use a factoring company near me, Everything can be done digitally or via mail. Traditionally businesses would have use the services of a local factoring company, as they would have been known or introduced to them by their accountant.

All factors now offer their services nationally with some offering factoring internationally. The most over riding thing is that the factoring provider you use is that you can work with them.

Read more: Why do companies use factoring?

F.A.Q’s

Who pays the Factoring Company?

Your customer pays the factoring company as the factor has purchased the invoice from your at a discounted rate. This means you no longer own the security of the debt and the factor now is the beneficiary. If you are using an Invoice Discounting facility your customer pays you into a third party client account.

How does a factoring company make money?

A factoring company makes money on the factoring fees invoice that they have purchased at a discount. All factors have a different fee structure. Some will only charge a fee that is determined by the monthly volume of invoices submitted and the creditworthiness of a customer's clients is determined by the factor rate.

Business Finance specialist at Invoice funding | + posts

Seasoned professional with a strong passion for the world of business finance. With over twenty years of dedicated experience in the field, my journey into the world of business finance began with a relentless curiosity for understanding the intricate workings of financial systems.

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