The Benefits Of Debt Factoring
Debt factoring has been established as a method of raising working capital for hundreds of years. Over that time, numerous product variations have emerged until today there are a diverse variety of services and optional extras available. The many benefits of factoring often outweigh traditional business loans and overdrafts offered by banks.
In essence, there are four basic services of which the factoring company will offer their client, some combination:
- Pre-Payments (also known as initial payments or early payments)
- Credit Control
- Sales Ledger Administration
- Non Recourse Bad Debt Protection
The first is a Prepayment against the credit invoices that the client raises. When a business first takes up a factoring facility there will normally be an outstanding sales ledger of unpaid invoices. The factoring company will make available a prepayment against these invoices, often up to 85% of their value, and this can create a substantial cash injection for the business. As the business continues to raise invoices, they are passed to the debt factoring company who will provide further funds against those invoices.
The factors early payments are then repaid as the invoices are paid by the customers. In this way the facility is of a rolling nature that will grow in line with the sales that the business makes. This can be considerably more attractive than traditional overdraft lending which is often much less flexible and tends to be a fixed amount with the need to reapply for increases. These funds can be put to good use within the business e.g. settling supplier invoices early in order to receive further discounts.
This is an invoice collections service whereby the debt factoring company will employ letter and telephone based chasing techniques to ensure that payments are received from customers on a timely basis. Indeed, a factoring company can often improve the overall debt turn (the average number of days in which sales invoices are paid) of its client which creates a further cash flow benefit. The other advantage of outsourcing debtor credit control is that a factor can often offer this at a fraction of the cost of employing one or more members of staff. This can translate into another tangible saving for a client. Even where the owners of small businesses handle the credit control themselves, it has to be carried out during office hours and this is time that the factor can free up for the owner, enabling them to spend that prime time seeking new sales.
Sales Ledger Administration
This is part of the service whereby the factor will create and maintain a debtor sales ledger for the client's business. As invoices and cash are received so the factor will post them to the ledger and the factor will provide this information to the client either via electronic links or paper print outs.
Non Recourse Bad Debt Protection
This is normally an optional additional service whereby the factor will protect the client against non payment by customers that the factor has pre-approved, usually to a specified credit limit. The client will normally advise the factor of the details of new customers that they wish to trade with and the factor will investigate the credit standing of that business in order to grant a credit limit. The client can choose to exceed the level of the limit that is granted but if they trade within the limit they will enjoy the peace of mind that comes from knowing that they will get paid by the factor should the customer go bust or fail to pay by reason of protracted default.
A large number of Uk businesses use debtor factoring and on average a clients choose to stay with their providers for a number of years. This supports the case for debt factoring as a cost effective way of saving money and raising working capital for expansion.