Invoice factoring is a fast way to raise cash by ‘selling’ your invoices to a large factoring company for a fee and who then collect the debts from your customers.
It’s different from invoice discounting since the whole credit control function is carried out by the factoring company. It is usually suitable for smaller businesses that don’t have the resources or time to set up credit control functions.
The usual upfront cash amount ranges up to 85% of the value of the bill, which you receive within 24 hours of raising the bill. The balance will be paid minus the factoring fees after the debt is collected by the factoring company.
So what are the advantages?
1. Get up to 85% of the value of bills upfront to enhance cashflows
2. Outsource the headache of debt collection to a large and professional credit control function
3. Pay your suppliers earlier with potential for early settlement discounts
4. Improved cashflows will enable capital spending and financial planning
5. Easier than getting bank borrowing/overdraft, so useful for startups and early stage companies
The amount of upfront cash you can get will be determined by the quality of the customers and the industry sector and fees would usually range up to 5% of the value of the sales. There would also be annual fees to pay for the debt collection part. As expected, there are disadvantages as well.
Other than the fees which can range up to 5% of the value of your sales and additional annual fees, the main disadvantage is that it puts a barrier between you and your customer. Especially for early stage companies when customer relationships are being built, the introduction of a ‘outside’ debt collector can damage your reputation. If you’re building a relationship with customers, getting the bills paid is part of it.
From my experience, I have always wondered why companies especially ones that have been established for a while would go into factoring. The moment I see details of a factoring company on a supplier bill, it raises the issue of whether the company is in financial trouble.
So reputation is all important and my preference would be to use invoice discounting rather than factoring and keep the debt collecting process in-house.