- 14 Jan
How Does Factoring Improve Your Cash Flow?
Improving cash flow can be a major dilemma for a business. Often money is just not being received fast enough to meet your outgoings in a timely manner.
The effects of having poor cash flow may include:
- Not being able to pay your creditors on time (or at all).
- Being under constant pressure from creditors pressing for payment.
- Being unable to meet your staff payroll.
- Owing tax e.g. VAT, PAYE or NI contributions.
- Constantly having to chase up unpaid invoices.
- Being unable to draw money for yourself out of your business.
- Not being able to focus on growth and sales.
If you cash flow gets too bad, creditors such as trade creditors (that you purchase supplies from) or HMRC could end up taking legal action against you, and that could lead to your business ultimately being wound up. Keeping the cash flowing through a business in essential, and using factoring is one way of improving that money flow.
How Does Factoring Improve Cash Flow?
The main way that factoring improves business cash flow is by bridging the gap between raising invoices (or applications for payment in some sectors such as construction) and receiving the money in your account. The factoring company will make a "prepayment" against your invoices (subject to certain criteria). Typically this might be 85% of their face value - unlocking the majority of the cash tied up in your sales ledger. The remaining 15% is normally passed onto you when the customer pays, less the fees to use the factoring service.
Quicker Customer Payments
There are some other ways that factoring can improve the cash flow of your business. Firstly, you normally receive a credit control service as part of a factoring package. This can have a number of financial benefits. You don't need to employ your own credit controllers (depending upon the type of factoring service that you are using), so this can lead to a cost saving, reducing the financial burden on your company.
Secondly, using a professional credit control service often improves the efficiency of your debt collection. The process used is likely to be well structured to maximise effectiveness, and often just the name of a large factoring company can encourage customers to pay in a more timely manner. There is a knock on benefit to your cashflow. The quicker customer payments are received, the faster you get access to all those residual percentages of your invoices (the 15% in the example I used above). Again, the faster you are paid the better your business cash flow.
Improving Business Cash Flow
So hopefully that has explained how factoring improves cash flow. If you need some general tips about improving cash flow see our related article. We also have an article that sets out a detailed worked example of how using factoring affected your cash flow forecast so you can see step by step how the numbers work, so that you can factor in the positive effect of using a factoring service when you are constructing your future cash flow forecasts.