For most businesses, there will come a time when an injection of funds is required, but in such a fast-paced, metamorphic business landscape, it’s no surprise that the financial world favours immediacy.
So how can a business get the finance it needs? What are the options? And how can it get organised to ensure it gets a yes from the lender? Let’s think about Invoice Factoring.
What is Invoice Factoring?
Invoice factoring is a form of debt financing which allows businesses to borrow money to the amount of their outstanding invoices. This form of funding grants businesses quick access to cash and is relatively low-risk in comparison to other forms of debt financing.
Invoice Factoring is commonly used by businesses as a short-term cash flow stabiliser, rather than for making a large capital investment.
Factoring invoices are usually suitable for businesses offering contracted work or companies that trade with other businesses or government agencies.
How Does It Work?
The first step in invoice factoring is completed when the borrowing party issues a bill to their customer on an account due in a 90-day time frame.
The business then sells their accounts receivable to a lender e.g. a lender gives the business the cash due on the invoice before the client pays. When the client pays the lender then receives their cash back. There is a fee and the application process varies depending on the provider you choose.
It should be noted that once you submit your application the lender will assess how eligible you are as a debtor – criteria to consider include; the amount the business wishes to borrow, the sum of their open account(s), the credit history of the business’s customers and any other credit risks.
Once an application is approved, the factor can then release a portion of the requested fund to their debtor, this is typically 80% of the borrowers’ pending invoices – this is referred to as the ‘advance rate’. Risk factors that can affect the advance rate are the debtor’s industry and the size of the transaction.
Following approval, a business’ customer will be notified that the company has assigned receipt of outstanding invoice payments to the factor, this is known as a ‘notice of assignment’ and allows remittance to be dispensed into a lockbox account.
If a client pays the sum of the unsettled invoice and meets the terms of the original invoice, the factor is then able to forward the borrower the remaining invoice amount. This will include the deduction of factoring fees also referred to as a ‘reserve amount’.
Invoice factoring is a great way for businesses to release tied up funds from unpaid invoices.
This process saves time as businesses don’t have to wait for their customers to pay their bill. Furthermore, admin time is saved as most factoring providers will pursue invoice payment directly from the client.
Invoice factoring also allows the business to manage their cash flow more easily as the payments are dispensed in instalments.
Like most other forms of debt financing, factoring providers charge disbursements monthly in addition to other extra fees.
Factoring companies can set stipulations for debtors based on how many regular customers a business gets and how much foreign trade they do.
Small businesses often prefer to maintain working relationships with their clientele, and this can be made difficult if factoring companies manage credit control as they take over the customer liaison role.
Is Invoice Factoring Right for Your Business?
The Asset Based Finance Association (ABFA) have reported that over 45,000 businesses across a range of industries are currently using invoice factoring in the UK. If your customer base trades on credit terms, you would like to increase your working capital or grow your business and you need an immediate cash flow boost, invoice factoring may be worth considering.
Cottons Chartered Accountants and Invoice Factoring
Cottons understand what a business needs to do to secure invoice based lending. Recently we notably assisted a client in achieving invoice finance in less than three weeks through Close Brothers and enabled a company takeover.
Talk to us about getting your business in shape for finance and introducing you to the correct lenders.
Cottons have chartered accountants in London, Northampton, Rugby and Daventry. Our local offices support local businesses of all sizes with a firm understanding of their individual economic areas. Contact us if you would like to know more about our reliable tax and accounting services for your business.