More information on factoring

Factoring allows you to raise finance based on the value of your outstanding invoices. Factoring also gives you the opportunity to outsource your sales ledger operations and to use more sophisticated credit rating systems. Once you have set up a factoring arrangement with a Factor, it works this way:

Once you make a sale, you invoice your customer and send a copy of the invoice to the factor and most factoring arrangements require you to factor all your sales. The factor pays you a set proportion of the invoice value within a pre-arranged time – typically, most factors offer you 80-85% of an invoice’s value within 24 hours.

The major advantage of factoring is that you receive the majority of the cash from debtors within 24 hours rather than a week, three weeks or even longer.

In return,

* The factor issues statements on your behalf and collects payments – this includes contacting late payers by phone and pursuing outstanding invoices. Your company will, however, remain responsible for reimbursing the factor for bad debts, unless you have arranged a ‘non-recourse’ facility. Non-recourse means that if a debtor doesn’t pay, the factoring company will either suffer the loss or will have insured themselves against the loss. Hence, with non-recourse factoring you would not suffer.
* You receive the balance of the invoice (less charges) once the factor receives payment.
* The factor provides regular reports on the status of your sales ledger – you should expect regular statements. Many factors can offer you instant online account information.

Not all businesses are eligible for factoring. Since factors operate to make money for themselves as well as for their clients, there are a number of things to take into account. The factor audits the potential client’s books and accounts to establish that its sales ledger meets its criteria.
General Features of a Factoring Client

* Most companies which use factoring have a turnover of more than 200,000 although some factors will consider start-ups and companies with turnover of 50,000 or less.
* Generally, there should not be just a few customers.
* Typically, no one debtor should account for more than 25-40% of the business.
* Factors only provide finance to businesses dealing on trade credit terms.
* Factors prefer businesses that offer customers the standard credit terms for the industry.
* The company should be collecting your debts within a reasonable time frame.
* Businesses such as builders and advertising agencies which are paid in stages, and whose bills are often questioned, may not be able to use factors.
* Too many small invoices may make factoring uneconomical.
* Businesses whose sales are declining could find factoring difficult to justify.
* Where credit limits are required by the factor, you and the factor must agree how they will be handled.
* For non-recourse factoring (where the factor protects the client against bad debts) the factor will usually set credit limits for each customer.

Factoring Charges/Fees

Finance charges should be comparable to an overdraft. Typical charges on the amount financed range from 1.5% to 3% over base rate, with interest calculated on a daily basis.

Credit management and administration charges, including the maintenance of your sales ledger, depend on turnover, the volume and number of invoices. Typical fees range from 0.75% to 2.5% of annual turnover. A company with 50 live customers, 1,000 invoices per year and 1 million turnover might pay 1%.

Credit protection charges (for non-recourse factoring) largely depend on the degree of risk the factor associates with your business. Typical charges range from 0.5% to 2% of annual turnover.
Advantages

There are many advantages to factoring, including:

* You maximise your cash flow as factoring enables you to raise up to 80% or more on your outstanding invoices. An overdraft secured against invoices could only raise up to 50%.
* Using a factor can reduce the time and money you spend on debt collection since the factor will usually run your sales ledger for you.
* You can use the factor’s credit control system to help assess the creditworthiness of new and existing customers – this is especially useful if you do a lot of business with companies whose turnover is lower than 1 million and who do not have to file full returns with Companies House.
* Factoring can be an efficient way to minimise the cost and risk of doing business overseas.

Disadvantages

Of course, there are disadvantages to factoring and here are the most important ones to consider. Unless carefully implemented, factoring can have a negative impact on the way a business operates.

* The factor usually takes over the maintenance of the sales ledger. Customers may prefer to deal with the company it is trading with rather than a factor. However, if the factor’s techniques are clearly agreed beforehand, there will usually be no problem.
* Factoring may impose constraints on the way to do business. For non-recourse factoring, most factors will want to pre-approve customers, which may cause delays. The factor will apply credit limits to individual customers (though these should be no lower than prudent credit control would suggest).
* The client company might only want the finance arrangements and yet it might feel it is paying for collection services they do not really need.
* Ending a factoring arrangement can be difficult where the only exit route is to repurchase the sales ledger or to switch factors and that could cause a sudden shortfall in your working capital.

Factoring charges
Factoring charges are normally split into two types: service charge and interest charge:

Service charge description

A flat percentage fee is charged on every invoice factored. This percentage fee is irrelevant to interest rates and is agreed at the beginning of the contract. The service charge fee is normally subject to a minimum yearly fee which is charged if all invoices factored in the contract period do not meet this amount based on the applied percentage.

The service fee is collected by the factor out of the balance of each invoice which is collected prior to the balance being paid to you.

Normal service charge range

The range of service charge goes from as low as 0.1% for large turnover invoice discounting facilities to 4% for small turnover, high service factoring facilities.
However the normal range for factoring facilities is between 0.4 to 0.9%.

Sample service charge on a 25,000 invoice

As a guide we have used a sample 25,000 invoice which is being fully factored and remains unpaid for 60 days (sample base rate is set at 5% APR) :
Invoice value: 25,000
Advance rate: 85%
Next day payment: 21,250

Factoring service charge: 0.75%
Factoring fee: 59.40

Interest charge description

As part of a factoring service money is lent with invoices as the security. As with most other types of lending there is an interest charge applied to the money that is lent. Unlike the service charge, the interest charge is an annual percentage rate.
The interest fee is charged on the money borrowed against each invoice and is charged when each invoice is collected.

Normal interest charge range

Normal factoring interest rates are comparable, if not lower, than overdraft APR charges.
The range is from 0.5% over base rate for an invoice discounting facility to 4% over base rate for a small factoring facility with the normal APR being 2% over base rate.

Sample interest charge on a 25,000 invoice
As a guide we have used a sample 25,000 invoice which is being fully factored and remains unpaid for 60 days (sample base rate is set at 5% APR) :
Invoice value: 25,000
Advance rate: 85%
Next day payment: 21,250

Interest rate: 2% OBR (7% total)
Interest fee: 244.50

What is the difference between recourse and non-recourse financing?

In a normal recourse factoring agreement if an invoice remains outstanding for more than an agreed period the money borrowed against that invoice from the factor must be repaid. Depending upon the size of the unpaid invoice this may cause a significant impact on the cash flow of your company until that cash can be collected.

Non-recourse factoring has been created to provide a solution to such potential problems by combining a credit protection policy with a factoring agreement to ensure that once an invoice is agreed to be factored it cannot be placed back with you.

To offer such as service many factoring companies offer the credit protection themselves while other have created relationships with insurance companies who hold the risk.

Non-recourse factoring is more expensive than a normal factoring agreement because of the cost of the addition protection service which is usually charged at between 0.4-0.75% of the value of each invoice factored. The factor will retain the right to exclude some of your clients from this non-recourse cover however they may suitable for normal factoring. In addition, the advance rates against clients may be reduced depending upon the agreement the factor requires.

It is always worth asking for a quote to cover a non-recourse facility while you are enquiring about a normal factoring agreement to allow you to compare costs and asses the potential benefits.

Invoice discounting can also be offered on a non-recourse basis.