Invoice finance and factoring - the pros and cons

   

If you’re doing well enough that your business is growing rapidly – and there are plenty of businesses achieving that no matter what you read in the media right now – then you may find yourself in a unique financial situation.

And that’s where you are selling so much that you can’t get the money in the door fast enough to pay for the next batch of products.

It’s a common problem, especially for businesses that issue invoices on 30 day terms and find some clients prefer to extend their terms to 45, 60 days or longer.

Without the cash in the bank from previous sales, where are you going to find the money to pay for future supplies? It’s a huge problem, especially if your business is new and you are struggling to secure adequate credit terms.

There are a number of options round the problem including borrowing money with a loan or overdraft to create more working capital. A less risky way of borrowing could be to use something called factoring.

This is where you effectively borrow money secured against invoices you have issued. How it works in practice is that you send a copy of every invoice issued to your factoring company. It will then “lend” you a percentage of that invoice and collect payment due itself. The balance due is then paid to you.

For example, let’s say you raise an invoice for £1,000. You give this to the factoring company, which straight away gives you 90% of the value of the invoice, in this case £900.

30 days later it chases your customer for full payment of the £1,000 invoice. When you customer has paid you get the remaining £100, minus a fee and interest on the money you have “borrowed”.

Factoring has been around for thousands of years, with some historians tracing it back to the Roman Empire and further. But it isn’t for every business. Bytestart examines the main pros and cons.

Factoring as your friend

Positive cash flow: There can surely be no smarter way of keeping a positive cash flow than factoring. The perfect world where customers pay immediately doesn’t exist so this is the next best thing. The money is in your bank account much faster, making it less likely your business will run out of cash while it grows.

Get cash fast: If your business has a number of outstanding invoices now, a factoring company may be able to pay a high percentage of them to you quickly.

Better financial planning: Because you know exactly when the money will hit your account you can take much more calculated financial risks. You may also find it easier to attract investors and borrow capital as you can prove a regular cash flow.

Have more knowledge about your customers: Many factoring companies insist on credit checking your customers before you offer them credit. This reduces risk for everyone. There’s no point selling something to a customer who doesn’t have the means to pay.

Highly competitive industry: There are a lot of players in the industry, which is great for keeping prices low.

Makes you seem more professional: Some customers may respect a factoring company more than you (!) meaning they may pay more quickly. This could be the case if you use the factoring services offered by the big name banks.

Avoid bad debts: If you enter into something called “non-recourse factoring”, the factoring company is responsible for the debt if it turns bad. Of course this works out more expensive than “recourse factoring” where any debt problem is still yours.

You can get an online factoring quote right away from Lloyds TSB Commercial Finance.

Factoring as your foe

Cost of borrowing: Factoring is still a form of borrowing and there’s a cost associated with that. You will pay a fee for every invoice factored, plus interest on the money you have “borrowed”. So slow-paying clients will still cost your business money.

Lose control of how you do business: Your factoring company may demand a say in the kinds of customers you take on (or rather the kinds of risk you take) and how you do business. You may find your terms & conditions have to be changed, and clients are told how the factoring company likes things to be done.

Lose control of debt management: The factoring company will take responsibility for chasing up outstanding debts. And that means strangers working for another company ringing up your clients and demanding cash! You may also find that a factoring company will not accept new invoices for some customers while other invoices are still outstanding, even if your business is happy to take the risk of the extra business.

You are still liable for bad debts: With “recourse factoring” the debt problem is still yours. So you will still lose money on clients that don’t pay. Factoring companies will ask for their advance on the invoice to be returned, often within a fixed period of time. And of course they may take the money from future advances, which will affect your cash flow.

Hard drug to stop taking: The final downside of factoring is the fact it is like a drug. Once your business is reliant on factoring for good cash flow, it will take an injection of capital to ween you off it.

Further Factoring Resources

• Get an online factoring quote right away from Lloyds TSB Commercial Finance.
• How factoring can free up your business cashflow
• Invoice finance and factoring guide for small companies
• How to choose an invoice finance provider

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