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.
* 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.
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.