- 23 Sep
This is our free factoring guide that will give you access to all the information that you could want to know about the use of this type of financial service for businesses.
Our factoring guide is to help businesses that are considering using a service, or are already using a service. It will explain how the various product variations work, what the costs are, the benefits and things to watch out for.
There are definitions of invoice factoring online but many of them have their limitations. Also, in the UK we tend to define factoring slightly differently to some other countries. This is our own definition of factoring:
"Factoring is a financial service for businesses that provides both prepayments against unpaid sales invoices raised to other businesses, and a credit control service."
In simple terms factoring means that a business can receive a "prepayment" against its unpaid sales invoices (typcially between 70% and 100% of the invoice value), so that they don't have to wait for their customers to pay. This can dramatically improve their cash flow. When the customers do eventually pay, the balance of the invoice, less charges, is passed onto the business.
If the business has a whole sales ledger of outstanding credit invoices raised to other businesses, a large tranche of cash can be released in one go, when the prepayments against each invoice are combined. This type of financial facility can significantly improve their working capital position quickly.
As new invoices are raised, so new prepayments are released. Hence, if the turnover of a business increases, so does the amount of funding they can access. This is why these facilities are very popular with fast growing businesses.
Other Similar Products
The service fits into a family of financial products called receivables financing or invoice finance. Those umbrella terms describe all the services that provide prepayments against invoices. The other branch of products are known as "invoice discounting" (or ID). The difference is that ID doesn't include the credit control service. Some businesses prefer to handle the credit control themselves, others prefer to outsource it. Factoring is for those that want the credit control service, in addition to the prepayments.
You should be aware that just to confuse matters, some people use these different product terms interchangeably, which does not help why you are trying to understand what the service you are being offered includes.
A Short Video Explanation
See our 30 second video explanation of factoring, below:
Invoice Factoring Companies
These services are provided by "invoice factoring companies" also known as "factors", of which there are over 100 in the UK. Some are specialists handling particular types of products or industry sectors, others provide the full range of services.
So which is the best factoring company? Watch the short clip below:
There are a broad range of different types of provider. Some are bank owned, others are independent. Even the independents range in size from FTSE 250 groups down to small companies that have few employees. Also there are many fintech platforms (web based services). Some are members of bodies, such as UK Finance, but not all are.
We have undertaken extensive service quality comparison research between different providers. we have found that average service quality ratings (given by existing clients) have ranged from 4 out of 10 up to 9 out our 10, depending upon the provider. We have found a 125% range between the worst and best service providers within the industry. This is a dramatic deviation that should be a concern for anyone thinking of using these services. We can provide guidance about service levels to our clients.
The type of partner that you choose will tend to be driven by the nature of your situation and what you need. Service levels will vary between providers, as will the level of funding and even the sectors that they will and won't handle. Also not all providers offer all product options.
These are the benefits to using such a service, they will vary slightly depending upon the product variant that you choose to use:
- Improved cash flow. You can use the additional working capital for any purpose, including settling pressing creditors, wages, HMRC or investing in expansion and taking on large orders and projects. You can also approach suppliers for discounts if you can now pay cash for raw materials and supplies.
- Raising funding to assist with acquisitions, take overs and mergers.
- Availability of finance to businesses that may not qualify for traditional forms of funding e.g. overdrafts and loans. The nature of these facilities means that the financier is in a safer position (relying on your book debts to recover their advance if required) so that they can take a more liberal view on providing funding. Factoring is particularly good in these instances as the funder has the additional reassurance that they are handling the credit control. This can enable them to be even more liberal with the funding provided.
- Protection against bad debts (optional).
- Confidentiality so that customers don't know you are using the service. The credit control is conducted by the funder but in the name of your business (optional).
- Cost savings from outsourcing your credit control activity. It can mean that you don't have to employ credit controllers or that you don't have to waste your own time undertaking that task if you are a small business.
- Help collecting export invoices (again if you select that option).
- Flexibility to dip in and out of using the service - if you choose a selective facility.
- Access to other additional add-on services such as payroll management and trade finance to pay for imports (if required).
- Electronic access - most providers have some form of electronic access package that allows you to submit invoices, draw down funds and manage your account via an electronic interface. Several offer apps so that you can control your facility via a smart device.
There are lots of product variations available, they are explained in detail in our article: Types Of Factoring.
- Selective factoring (also called "spot") or whole ledger finance (finance individual invoices or all of them).
- Domestic (for UK debts) and/or export for debtors abroad.
- Non recourse bad debt protection as an option.
- Confidential (debtor contact is conducted in your name) or disclosed (in the factor's name),
- Service only (credit control without any funding) or with prepayments.
The qualification criteria for factoring can be very broad. Providing you are a company raising invoices to other businesses on credit terms, you are likely to be able to find facility.
Even if you are in financial distress, because of the nature of this type of funding, you are likely to be able to be assisted even if you are experiencing trouble with creditor pressure or preferential creditor arrears e.g. HMRC, VAT, PAYE, NI bills that are due or overdue. The facility is based on the financial strength of your debtor book, rather than your business. Even new startups can access this type of funding when overdrafts and loans may not be available.
Different Provider's Criteria
The criteria will also vary between different providers. Some will take a more cautious view than others, not all will handle startups or companies that are in distress. However, there are various providers that will address all niches, and all circumstances.
How It Works
This In very simple terms this is how factoring works:
- You raise your invoices (or applications for payment in the construction sector).
- You submit them to the financier, normally electronically.
- The financiers makes available a percentage of the face value of the new invoices.
- You can choose to draw that money down into your bank account.
- The factoring organisation sends statements, chasing letters (if required) and contacts debtors if payments are not received.
- The money from the payments repays the prepayments.
- The financier makes available the remaining percentage of the invoices, less their charges.
There is more detail here about: How Factoring Works.
The pricing varies depending upon the type of product used and the pricing policy of the provider that you choose.
We have undertaken pricing comparison research, for products such as recourse factoring, and we have identified wide ranges in pricing quoted to the same company. For example, in a mystery shopper exercise, we found a pricing variation of 165% between the most expensive and the cheapest quote.
The way the charges are structured is explained in this article: pricing, it also has examples of indicative pricing for various sizes of business.
In broad terms the pricing is likely to be as follows:
- For selective (where you choose individual invoices to fund) c. 2% per month of the funds drawn, for the time the funds are used. Although not all fees are structured in the same way.
- For whole turnover (where you fund all your invoices - subject to approval by the funder) between 0.4% of turnover and 4% or turnover, with discount (similar to interest) charges at between 0% and 3.5% over bank base rate.
- For whole turnover, you can have alternatively opt for an all inclusive, bundled fee which starts from about £3,000 (+ VAT if applicable) per annum.
Even if you look at those parameters and think you need a better rate, it may still be possible to achieve that as the providers will often pull out all the stops to quote for a deal that they want to win. There are numerous pricing offers available at any time and there is a great deal of competition between providers.
The amount of funding provided varies again according to the product, the provider and their opinion of the level of risk that your account presents. Typically 85% if a normal headline rate for core sectors that are often funded. However, rates can rise to 100% for sectors such as car body repairs.
In sectors such as construction, 70% is a more typical funding percentage.
The actual level of funds advanced may be subject to additional deductions such as debtor credit limits, prime debtor restrictions and disapprovals due to ageing, to name but a few. When choosing a provider it is very important to understand exactly how they will calculate the level of funding and any restrictions that they will apply. This can be a tricky area on which you should seek advice.
This will give you a rough idea of the amount of working capital that you might be able to raise: Factoring Cash Calculator.
There may be a point at which either you, or your provider decide that you want to terminate the facility, this can be for a variety of reasons, and may or may not be subject to a period of notice - depending upon the circumstances. This process will be governed by the facility agreement that you have entered into. For full details about the termination process please see our: Guide To Termination.
Sometimes customers switch between providers, on average this happens once within the life of a client. This may be to achieve a cost saving, raise more money or change between product variations. There are processes in place to facilitate a smooth transfer between different providers.
UK Finance & Complaints Procedure
UK Finance is the trade body responsible for many of the providers within this market. However, not all providers are members. Those that are are subject to a code of conduct that is backed up by an Ombudsman process through which you can escalate complaints. You may wish to check if the providers that you are considering are members. Having said that, the level of complaints has been extremely low.
If you have an issue with your provider, we have extensive guidance on our website about how to deal with complaints about invoice finance.
If you need more help please call Sean on 03330 113622 but we hope you have found what you need in our free factoring guide.