Reviewed: 2nd February 2016
One of the major problems for many small business owners is gaining access to a reliable source of working capital. Being the life-blood of any company, positive cash flow is critical for business survival and growth; without it there is no business.
The problem is knowing where to find the best sources of working capital and the right type of finance, that does not mean excessive risk for the owners/directors. This is where invoice factoring comes into its own – being based on work already carried out makes invoice finance reliable as well as low-risk for both borrower and lender.
If we were to define factoring in a single sentence, it would be ‘advancing cash on the basis of accounts receivable.’ This quick summary belies a reliable, effective, and popular way to raise finance, and one that encourages businesses to grow.
To successfully use invoice factoring, however, your business needs to have minimal bad debts and a low number of debtor days, which translates to a base of customers who pay their invoices on time, most of the time.
Small business factoring means handing over control of your sales ledger and credit control activities to the lender. They contact your customers if invoices are not paid on time, sending out the usual reminders and statements of account.
You send out your invoices as normal throughout the month, but receive a proportion of each one from the factor, either on the day the invoice is sent, or very soon after. The proportion made available is generally between 80% and 90%, but this varies according to each business and the lender’s criteria.
So now you have regular access to cash each month, with lending based on work that has already been completed. This presents little risk for yourself as a small business owner or director, with no personal guarantees required and minimal paperwork when compared with a bank loan.
The business factor takes on responsibility for obtaining payment from your customer, a service for which you pay fees and charges when the invoice has been paid in full. The factoring company deduct these fees from the amount that is left to pay.
With invoice factoring, the perceived risk for the lender is also low. They choose their clients based on the past payment history of customers, and overall stability of each sales ledger. This offers them a degree of certainty over whether or not they will be able to collect payments in the long-term.
Ideally, small businesses require a constant flow of cash through the month in order to meet ongoing liabilities, but it doesn’t take much to disrupt a once positive cash position. Unexpected bills, the loss of a key customer, or a sudden market downturn are just a few common occurrences that can result in a spiral of debt if not controlled quickly. Having a finance facility that caters for unplanned events like this, and averts disaster, can provide the confidence to develop and grow to the next level.
‘With recourse’ or ‘without recourse’
‘With recourse’ means that a factor has the right to claim back the percentage paid to you if they are unable to obtain full payment from your customer. ‘Without recourse’ is the opposite, which may sound more attractive on the face of it, but will attract higher fees, and your credit control procedures will need to meet certain standards.
Confidential or Disclosed
You can hide the fact that you have sought invoice finance with a confidential factoring solution, but if confidentiality is not an issue for your business, the disclosed option may mean reduced costs.
As the name suggests, this could be suitable for companies with long-term or large contracts, where individual invoices can be factored out as and when appropriate.
Which type of factoring you choose depends on many different aspects, including how your business operates, whether it’s a product or service-based company, and the customer profile. The factoring company’s fee structure will also play a part in your decision.
The banks’ reluctance to lend to small businesses in recent years has led to invoice finance entering the mainstream of lending options. Some of the larger, long-established financial institutions run their own factoring departments, with many smaller independent lenders also making their presence felt.
Recommendations may be available from your business peers, or perhaps you already have links with a company that offers factoring services. As with any type of borrowing, however, it pays to make a comparison between several lenders to get a feel for what is right for your company.
Here at Real Business Rescue, we have long-standing business relationships with a wide range of lenders, including those offering invoice finance. We can discuss your needs and put you in touch with the most appropriate lender for your business type, ensuring that you understand the implications of the various factoring contracts that may be offered.