- 14 Apr
A good way of understanding how factoring works is to think of it as an advance against a sales invoice that hasn't been paid by your customer.
When you provide goods or services to a customer, you may raise an invoice, and this will typically be on credit terms. This means that the customer has a given period of time, normally 30 days in the UK, in order to pay the invoice.
The problem with this system is that it is often the case, that you will have to pay for raw materials, staff, premises and other expenses, in order to be able to fulfil the order. You may have to pay your suppliers, before you are paid by your customers.
This creates a cash flow problem. You have to lay out money prior to receiving payment from your debtors. If you are trading with a number of debtors, providing multiple different orders each month, you can end up with a sales ledger made up of numerous outstanding unpaid sales invoices.
In the UK, where typically 30 day terms are offered, you may have current invoices, those that are 30 days overdue and possibly some which are even older and further overdue.
In order to bridge the cash flow gap this creates, and access money so that you can pay suppliers and staff, a factoring facility provides you with an advance against your invoices. This advance is normally called a "prepayment" (or early payment).
Typically, a prepayment will be circa 85% of your invoice value, although this figure can vary between 70% and 100%, in some cases. Once the customer pays the invoice, the remainder of the value of the invoice is passed onto you, less the charge for using the factoring service.
The other benefit with a factoring facility is that you receive a credit control service to help you with chasing the outstanding invoice, if required. This can reduce, or remove, the need for you to employ credit control staff, which can lead to a significant cost saving. This saving is one of the key benefits from using this type or receivables finance.
Other Types Of Invoice Funding
There are other types of funding against invoices, which operate in different ways. For example, if you do not want to take advantage of the credit control service, there are facilities where that is not included – these are called invoice discounting facilities.
You can also choose whether you want to receive factoring advances against selected invoices, often called spot factoring, or all of your invoices, typically referred to as a full ledger solution.
Whichever option you select, the factoring advances are likely to significantly improve the cash flow through your business.