Factoring and Invoice Finance

Hugh Craen

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Factoring for business

Factoring originally started in the USA and was used to finance the textile trade on the East Coast of America. It was introduced to the UK about 40 years ago, but the real growth has been over the last 10 years partly as a result of the High Street Banks being less than enthusiastic about offering facilities to small businesses.

Factoring, in its basic form, is a way of financing your business by assigning invoices to a factoring company in return for an advance of up to 90% of the gross value of the assigned invoices. The name of the Factor will be printed on the invoices and your customer will pay the factoring company direct. On receipt of the payment the balance of the advance will be repaid to your company less charges. The percentage advance will vary according to the quality of the product and customer. The stronger your business, product and customer the higher the advance against the invoice.

The factoring company will issue monthly statements and reminders and effectively become an outsourced sales ledger department. Many small businesses find the more experienced methods employed by a factoring company a real advantage to ensuring their customers pay on time.

The costs are based on workload and risk. There are two charges, a factoring charge which is normally a percentage of the gross annual sales (sales including VAT) and an interest charge for the money that is advanced by the factor.

Many factors offer a bad debt protection against possible bad debts. There will always be an additional charge for this service.

http://www.findmeafactor.com/factoring.html

Is Factoring right for your business?

Firstly your business must be selling a product or providing a service that is acceptable to a factoring company. Ideally you must be able to show that an invoice is payable once the product or  service has been  provided to your customer. Most businesses are suitable but the following issues can be a problem to most factoring companies;                                                    

Goods sold on a sale or return basis                                                                                            Businesses that buy goods from their customers   Stage payments over a period of a contract     

Your customers must not have a clause in their terms prohibiting assignment of the invoice.

Your business must be selling to businesses or Government Bodies. Factoring companies cannot deal with businesses who sell to consumers. Factoring companies will expect your customers to be creditworthy. It is important that the majority of your customers are mainly within terms, factoring companies will not advance against old debts.

Your business will be expected to have a good accounting system that produces a robust paper trail that shows evidence that your customers have been provided with the goods stated on the invoice. Remember today’s customer may have to be taken to Court to obtain payment. Unless the paper trail is sound the debt may not be enforceable.

From your own point of view you will want to ensure that your business benefits from factoring. Lets look at the scenario below;-

Debtors              £100,000

Creditors              £30,000                                                                                 Bank Overdraft     £50,000

If we assume that the factor will advance against £90,000 this should  raise approximately £76,000. If the Bank overdraft has to be repaid the exercise will raise an additional £26,000. If the business is growing and the debtors figure grows to £150,000 then factoring will be a real bonus.

Remember an 85% advance is not automatic and a factor will advance less if your business does not satisfy all their requirements.

http://www.findmeafactor.com/factoring.html

What you need to know

In most cases Factoring companies will review each business with a view on risk and opportunities of providing a facility for finance, so businesses that show greater opportunity for growth and solid customer relationships will more often than not be offered favourable terms. We can help you to ensure that the business and its trading history is communicated effectively to the Factoring companies, we can also help to filter through the various lenders select those that may have preference for your business sector, such as with construction, manufacturing, retail or finance.

Do you already use Factoring or Invoice Finance, if so click here

Invoice DiscountingWhat is invoice discounting?

Invoice Discounting is a similar facility to factoring. With factoring, the factoring company manages the sales ledger, they issue statements, reminder letters and receive payments directly from the customers.

With invoice discounting you are responsible for managing the ledger and collecting the money from your customers. Unlike factoring your customer will have no knowledge of your arrangement with the factoring company as there is no notice of assignment on the invoice.

Invoice discounting has become increasingly popular  as many businesses are not keen to have a notification on their invoices. As the factoring company does not have the same level of control over the ledger they are more demanding in their requirements before offering such a facility.

Is Invoice Discounting right for my business?

Many of the points mentioned on the factoring page apply to invoice discounting.

However, because the factor is dependent on you for collecting their money you will need to demonstrate that your business has a good accounting package and that you have a proven record of managing your sales ledger. The money collected from the customers will have to be paid to the factor and they will need to be sure that your finances are sound as it is easy to pay such monies into the business account rather than to the factor. Such a practice represents a serious breach of the facility. 

Factoring companies expect businesses to be of a higher quality than those they will be offering factoring facilities to.

Charges for invoice discounting can be less than for factoring as the factor does not have to carry out all the sales ledger services that are associated with a factoring arrangement.

http://www.findmeafactor.com/invoice-discounting.html

Common problems with Factoring companies

The Factoring company will not increase my funding limit

If your business is growing satisfactorily and you have run the facility correctly there is no real reason why the factoring company should not support your growth. However sometimes the factoring company may become cautious because a similar business in your sector has had problems or caused them problems. It maybe because there is an overall limit on a customer that you are not aware of, or internal issues such as their own funding - the Factoring company in some cases may have internal limits that they cannot exceed.

Communication is often the key and because of our experience in the industry we are always in a position to advise the best way forward.

The Factoring company wants to renew the agreement on less favourable lending terms

It is very important to discuss terms of a future agreement well before the renewal date. All factoring agreements give details of notice period and some factoring companies will leave the renewal process as late as possible in order to give their client limited options. If the facility has run well and you have complied with all terms there is no reason why the agreement should be renewed on less favourable terms. However if the factoring company has had problems with the account they may wish to change the terms in order to give them more security and  this sometimes means increased charges.

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Common problems with Factoring companies

The Factoring company offered an advance of 85%, but in reality the overall advance is much lower

This is a common problem. Most people looking for a factoring facility are focussed on the percentage advance and do not look at the other key terms. You may have been offered 85% but the factor may have put in a clause setting low limits on your customers and included a concentration limit which again restricts funding. So whilst you have been offered an 85% advance you could in reality be drawing down less than 70% of your ledger.

Findmeafactor.com will look at what you are being offered and propose a solution.

The Factoring Company want to change my confidential Invoice Discounting Facility to a Factoring Facility

It rather depends on how difficult trading has been and what effect it has had on your facility. Many Factoring companies include clauses which allow them to change the terms if your circumstances change. If the Factoring company feel their security has been weakened they may well wish to impose changes.

FindmeaFactor.com can look at the situation and advise you whether the changes are fair and assist in reducing the impact of those changes

http://www.findmeafactor.com/contact-us.html

Common problems with Factoring companies

My Factoring company has been taken over

Over the last few years a number of factoring companies have been sold and any change of ownership can have an effect on your business. Any new owner may have their own way of running things that may not suit you.

It is vital to meet representatives of the new owners in order to ensure that the terms of your agreement are not going to be adversely changed or amended. Give us a call to discuss your situation. Certainly do not sign anything until you have spoken to us.

My Factoring Company has ceased to trade

You do not expect your funder to go bust, however it has happened twice in recent years and I am sure it could happen again. Such an event will have a serious effect on your business as it is likely that there will be no further money available to you.

If you are in the UK Find Me A Factor's team will look at what you are being offered and advise you whether you are being treated fairly

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Factoring terminology and frequently used terms

Factoring - A financial arrangement whereby a business assigns invoices to a factoring company in return for a monetary advance against the invoices and a sales ledger service.

Re-Course Factoring- A factoring arrangement where the financial risk of customer failure stays with Client rather than the factoring company.

Non-Recourse Factoring- A factoring arrangement where the factoring company will carry the risk when there is customer failure. It is important to note that the factoring company will not offer risk cover on every customer, only those who are credit worthy.

Credit Insurance - An insurance policy that covers the risk of bad debt failure on your customers, Credit insurance companies will generally cover between 85% and 90% of the outstanding balance excluding the VAT element of the debt.

Disclosed Invoice Discounting - A similar arrangement to factoring apart from the fact that the factoring company does not manage the sales ledger.

Client - Technical name for the customer of the factoring company.

Debtor - A debtor is a business that owes money as opposed to a creditor who is a business that you owe money to.

Factoring terminology and frequently used terms

Confidential Invoice Discounting - A facility where the factoring company has no involvement in managing the ledger and the customers have no knowledge of the involvement of the factor.

Discount Charge - The interest charge levied by the factoring company on monies advanced by the factor. Rates are normally quoted as a percentage over base rate. As with Banks there will often be a minimum rate charged.

Advance Rate or Initial Payment - The percentage advanced against assigned invoices. This percentage is against the gross value (including VAT).

Factoring Charge - The service charge normally represented as a percentage of gross annual sales for operating a factoring arrangement. The service charge is levied monthly in arrears as a percentage of the invoices raised in the previous month.

Re-Factoring Charge - An additional charge when an invoice becomes of a certain age. Not all factoring companies levy a re-factoring charge.

Minimum Annual Charge - A factor will always impose a minimum charge that will cover any shortfall should the factoring charge not cover their basic costs. In general the greater the turnover the lower the percentage factoring charge (it has been known that a prospect will inflate projected sales in order to get a better rate).

Personal Guarantee - A document signed by a director of the client company confirming that in the event of the factor losing any money for whatever reason that director will make good that loss. Some guarantees are for fixed amounts.

Factoring terminology and frequently used terms

Corporate Guarantee - As above but signed by a corporate body such as a limited company or a limited liability partnership.

Warranty - An undertaking that the person signing the warranty will repay the factor any loss as a result of breaching material clauses, such as raising false invoices or not passing customer payments to the factor. This is often called an anti-fraud warranty.

Concentration - A factor will impose a restriction on a single customer who represents a large proportion of the outstanding ledger. For example if one customer owed £60,000 out of a total ledger of £100,000 and the factor had a concentration limit of 50% then £10,000 would not be funded.

Factoring Agreement - The formal document setting out the terms of the facility. These documents are generally of a standard type, with extra clauses being inserted to cover additional circumstances

Debenture - A charge registered against a company showing that a lender has taken security over certain assets. This charge is registered at Companies House.

Waiver - Also known as a deed of priority. If there is more than one debenture this document sets out who has a charge over what assets and the order of priority.  

CHAPS - An electronic transfer of money from the factor to the client. This method will deliver cleared funds to your account on the day of the transfer. The charge for this transfer varies between companies but expect to pay in the region of £30 plus VAT for each transfer.

BACS - Similar to the above, however it normally takes three or four days to receive the transfer. Normally BACS transfers are free of charge.

Factoring terminology and frequently used terms

Working Capital is equal to Current Assets minus Current Liabilities

Corporate Voluntary Arrangement (CVA)  An insolvent company can enter into a company voluntary arrangement (CVA). The CVA is a form of arrangement, where an insolvency procedure allows a company with debt problems or that is insolvent to reach a voluntary agreement with its business creditors regarding repayment of all, or part of its corporate debts over an agreed period of time. A CVA can be applied for by; the agreement of all directors of the company, the legal administrators of the company, or the appointed company liquidator. A company voluntary arrangement can only be implemented by an insolvency practitioner who  will draft a proposal for the creditors. A meeting of creditors is held to see if the CVA is accepted. As long as 75% (by debt value) of the creditors who vote agree then the CVA is accepted. All the company creditors are then bound to the terms of the proposal whether or not they voted. Creditors are also unable to take further legal actions as long as the terms are adhered to, and existing legal action such as a winding-up order ceases.

During the CVA, payments are made in a single monthly amount paid to the insolvency practitioner. The fees charged by the insolvency practitioner will be deducted from these payments. The company is not required to fund any further costs. Factoring Companies are comfortable financing companies who have entered into such arrangements as the company is protected from any action by the creditors who are bound by the CVA.