Invoice factoring

Invoice factoring is the process of selling your business' invoices to a third-party known as a Factor. On issuing an invoice, the Factor immediately pays a proportion of the invoice value to your business, improving cash-flow. In due course, your customer settles the invoice directly with the Factor (in contrast to invoice discounting) and the Factor then pays the balance of the invoice amount less a fee for their services.

The details

Invoice factoring involves entering into an agreement with a Factor under which they become the owner of invoices your business issues. The agreement usually covers all invoices and operates as follows:

• Your business issues a 'factored' invoice to your customer. The invoice instructs them to pay the Factor directly.
• The Factor immediately pays a percentage of the invoice amount to your business – usually up to 80% or 90%.
• The Factor assumes control of the debt and chases your customer for payment if necessary.
• Your customer makes a payment direct to the Factor.
• The Factor pays the balance of the invoice less their fees to your business.

Fees usually include a 'discount charge' which is similar to interest and credit management fee to compensate the Factor for taking charge of your invoices.

If your customer fails to pay then there's a question over who is liable. This depends on the detail of your factoring agreement. If it's a "recourse" agreement then your business is liable to pay back to the Factor the money they advanced – and it may still be liable for the fees, too. On the other hand, if it's a "non-recourse" agreement then the Factor absorbs the loss. Your business doesn't have to repay the advanced money, although again it may still be liable for fees. "Non-recourse" factoring arrangements have higher charges to cover this risk.

Who provides invoice factoring services?

Factors are usually specialist independent finance providers or part of the major banking groups.

Who is invoice factoring suitable for?

Businesses who issue invoices with payment due at a later date (so it's not usually suitable for businesses who deal in cash or debit/credit cards where cash advances may be more suitable).

Advantages

• Invoice factoring can provide an excellent boost to cash-flow / working capital
• The Factor deals with chasing payments etc., reducing the internal costs of your business
• Some Factors will even help with other aspect of your business, for example improving the quality of your customers through credit-checking

Disadvantages

• Fees imposed by the Factor will reduce your profits
• Factoring agreements can be complicated and hard to terminate
• Factoring is visible to your customers, some of whom may not look upon it favourably