- 01 Jul
Why Is Factoring Used?
Factoring accounts for almost 52% of UK finance member’s domestic factoring and invoice discounting clients by number (according to the Q2 2019 statistics). Therefore, it is the more popular option for UK businesses.
However, whilst this popularity may be driven by choice, it could also be that some clients are failing to qualify for invoice discounting and are therefore going down the factoring route. Invoice discounting often has higher criteria for qualification than those required for factoring.
Why Is Factoring Used?
The main benefit of using a factoring facility is that it will dramatically improve the cash flow of your business. A factoring company will provide pre-payments against your customer invoices. This means that you will no longer be waiting around for customers to pay, before you can use that money.
Prepayment levels will vary but typically they can be from around 85% up to 100% of your invoice values, depending on the particular type of product that you use. The balance is passed to you once invoice is paid (less the fee to use the service).
The fact that you get the majority of the value immediately means that the cash benefit can be substantial. If you are sitting on a sales ledger of say £100,000 worth of unpaid customer invoices, you could raise £85,000 immediately against those unpaid invoices. This will have the effect of significantly accelerating the amount of working capital within your company.
The benefit is not limited to the initial payment against your outstanding invoices. As you raise new invoices, so you will receive pre-payments against them. As your business grows, so does the size of your sales ledger overall, and hence your overall prepayment. This is another popular reason for using factoring. The funding grows in line with the turnover of your business. This is not the case for other forms of business finance such as overdrafts and loans, where the amount of funding provided is a fixed amount (decreasing in the case of a loan).
In addition to this type of cash flow finance, there are other reasons why people use factoring. One of the core services included within the facility is the provision of a credit control function to chase customers for unpaid invoices. This is why the service is called factoring rather than being called invoice discounting (just the funding without the credit control service). There can be a lot of benefits to using a factor to provide the invoice chasing for your company. Firstly, they tend to have teams of experience credit controllers which means that you don't have to recruit such individuals into your business. This could be a significant cost saving but in some cases customers also appreciate the removal of the hassle factor associated with collecting in unpaid debts.
The other service which can be included with a facility is bad debt protection. This works by protecting against customers becoming insolvent, and therefore unable to pay. You are issued with credit limits by your provider and providing you stick within those limits, your invoices are covered. This stops your company taking a bad debt.
Often companies turn to factoring when they need a cash boost. This may be to purchase new stock, to pay creditors, settle HMRC tax liabilities or almost any other purpose. The ability to release significant sums tied up in your sales ledger means that using this type of facility can dramatically change the financial situation of your company.
It is also worth mentioning that it is very easy to qualify for factoring. Even if you have previous adverse credit history, County Court judgements against your business or previous failed businesses, you may still be able to access business finance through factoring. This may not be the case for other forms of factoring, such as traditional bank lending, which often requires a stronger credit history and a stronger financial position.
Factoring can be provided even in situations where businesses are loss-making or illiquid. In fact, it can often be the solution to improving the liquidity of your company.