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How factoring can free up your business cashflow

October 8, 2011

The lifeblood of any business is cash. You need good cash flow to keep your business viable. In some ways it’s more important than turning a profit – it’s not unheard of for profitable businesses to go under, just because they ran out of cash.

When you’re starting up, cash flow will be your biggest nightmare. It takes time to get a sales momentum going and for many businesses, sales are slower than predicted. So you’ll be relying initially on whatever investment or funding you started up with.

Of course when you do win sales, you’ve got the work but might not see the money for another 30 to 60 days, depending what kind of industry you are in.

This is where businesses get into trouble, especially with the culture of late payment that exists in the UK. It only takes your largest client to decide to extend their terms by a few weeks to put your bank account under real strain.

Factoring – What is it?

If you struggle to get a bank loan or extended overdraft, there’s another option open to you to ensure you get your cash as soon as you have done the work.

It’s called factoring, where you effectively sell your invoices to another company. They will “loan” you about 85% of the value of the invoice within a day or so. In some cases, it’s then their problem to collect the money from your client, not yours.

When they get the cash they’ll pay you the remainder of the invoice minus their fee and interest on the amount loaned.

The two main types of full service factoring are known as recourse factoring and non-recourse factoring. With recourse factoring, the factor ultimately has no risk from a bad debt. If your client doesn’t pay after a certain period of time, then they will demand their advance back.

In non-recourse factoring they take on the risk of bad debt. This means if a client doesn’t pay you will only be liable for the interest on the outstanding debt. It’s the factor who will lose the main amount owed. Of course, because of the risk involved, this kind of factoring is more expensive.

Factoring – Advantages & Disadvantages

There are huge advantages to factoring. You can focus on running your business not worrying whether your clients will pay you. Because your cash flow is more predictable, it will let you make better business decisions and plan growth strategically. And bad debts can become someone else’s problem.

Some factoring companies will also give you free credit information on your suppliers and clients.

Of course there are downsides too. You can’t use factoring if you are a retailer or trade mostly in cash. You lose control over how your clients are dealt with – in a worst case scenario you could lose a client if they are dealt with aggressively by the factor. Your factor may also refuse to deal with clients they consider to be high risk.

And the biggest downside is the cost. While factoring can be reasonable for an outsourced function, you have a reduced profit margin on every sale you make. Expect to pay a fee between 0.75 and 2.5% of turnover, plus interest on the money that is loaned to you in-between your invoice being issued and your client paying.

Factoring is a complicated business relationship with a supplier, so ensure you are fully aware what you are getting into before you sign up.

More cash flow and financing help

For more help and tips here are a few of our other popular guides to help you to get customers to cough up in good time;

And these will help you with business funding options;