Invoice factoring is sometimes referred to as ‘factoring’, or ‘debt factoring’. It is a financial product that enables businesses to sell unpaid invoices (accounts receivable) to a third-party factoring company (a factor).

The factoring company buys the invoices for a percentage of their total value and then takes responsibility for collecting the invoice payments.

Invoice Factoring is an increasingly popular form of alternative business funding. This type of alternative finance has grown in popularity since it has become more challenging for businesses with imperfect credit to use traditional finance products from high street banks.

Summary
Invoice factoring is a type of accounts receivable finance. It’s designed to help provide working capital for those businesses who tend to experience longer payment terms with invoices.

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    How Does Invoice Factoring Work?

    Most factoring companies pay in two instalments, the first covering the bulk of the receivables (fulfilling your need for instant cash-flow) and the remainder when your client settles their invoice, minus any factoring fee. The basic steps are as follows:

    1. You submit details of your invoices to the factor to determine if you are eligible for the factoring facility. The invoice factoring company will then assess how risky they feel the loan is (this is industry specific, as well as about your particular clients) and will then give you their quote.
    2. Once agreement has been reached, the factor will advance you the money.
    3. The factor will then commence collection of the invoice with your customers
    4. Once the invoice has been collected, the factor will pay you the remaining balance of your money, minus their fee
    Summary
    After eligibility is established, the factoring company will purchase the unpaid invoices for a percentage of their value and then take over the debt collection process. The remaining amount owed to your business for the invoices will then be repaid once the factoring company has collected the total value of the invoices from your customers.

    Why Would a Company use Factoring?

    The simple answer to this is to speed up access to funds and incoming cash flow, as receiving payment for invoices can sometimes be a lengthy process.

    One of the problems for many businesses is that payment terms for invoices can be between 30 to 120 days, and this can lead to cash flow issues. The gap in cash flow during this period has often been filled by either bank overdrafts or business loans. This is where alternative finance such as this type of accounts receivable financing can add value.

    However, where businesses may have less than perfect credit these options may not be available. Invoice factoring, therefore, can offer a useful solution for similar situations.

    Summary
    Essentially, to attain much needed working capital where invoices are taking long periods of time to get paid.

    Advantages

    • A quick, safe source of cash flow by financing accounts receivable and releasing working capital tied up in unpaid invoices
    • It can lower time spent on administration and chasing late payments since the factor assumes responsibility for collecting the debt and
      take over the management of your credit control
    • Factoring amounts can easily expand and contract with your sales ledger.
    • Factoring is less expensive than turning to equity investors
    • As experienced debt collectors, factoring companies professional and ‘gentle reminders’ can improve your customers’ and clients’ payment times on a long-term basis.
    • Invoice financing can provide better cash-flow control where there may be different credit terms across your clients and customers

    Disadvantages

    • It could affect customer relationships since you must let your customers know a third party is involved with collecting your invoices
    • The costs are higher than a bank loan, so this type of finance works best for businesses with a high-profit margin that can absorb the costs.
    • May reduce the scope for additional borrowing
    • Loss of Control – Handing over responsibility to a third party for accounts receivable means you will have to give up an element of control
    A Guide to Invoice Factoring


    Can Any Business Use Invoice Factoring?

    Invoice finance is just as effective for small businesses and startups, as it is for larger companies. In assessing eligibility, factoring companies will look at several factors, including:

    • The size and origin of the invoices you’re seeking payment for
    • Time frames
    • Potential risks
    • Your own companies credit score and reputation

    This last consideration is less important since the real risk for the factor lies with the credibility of the business owing the outstanding invoice. This is because factoring companies are more interested in the strength of your customers’ credit, rather than your own.

    Invoice financing can be ideal for brand new businesses, startups and even companies with poor credit, as a means of attaining finance more effectively. The rates may simply be slightly higher, as a result for less established businesses, or those with bad credit.

    Summary
    Yes. Any business can use invoice factoring, but it may only be appropriate where invoices are taking 30-90+ days to get paid, to help with cash-flow.

    How Much Does it Cost to Factor Invoices?

    Invoice factoring costs differ depending on some factors including the value of invoices in question, the size of the company (small business factoring or factoring invoices for larger companies), and the apparent level of risk for the lending partner.

    The costs are broken down into a service charge, and the discounting or factoring fee (discount rate) itself. There may also be additional fees for things like credit protection, or a decision to end the service early.

    Read our full article here about invoice finance and factoring costs.

    Summary
    The fees for factoring will be different across the market, based on the size of turnover, value of invoices and risk involved.

    How Does a Factoring Company buy Invoices?

    Most factoring companies purchase invoices in two instalments. The first instalment – the factoring advance – covers about 80% of the receivable (this amount varies). The remaining 20%, less the factoring fee, is rebated as soon as your client pays the invoice in full.

    Here are the steps:

    1. You submit the invoices for purchasing
    2. The factoring company sends you the advance (e.g., 80% of the invoice)
    3. Your client pays 30 to 120 days later
    4. The factoring company sends you the rebate (e.g., 20%, less the fee)
    Summary
    Whilst the specific ratio can vary, it’s usually done in two stages. The first stage is the advance which is usually around 80% of the accounts receivable and the remaining 20% is purchased later.

    What’s the Difference Between Invoice Finance and Factoring?

    Invoice finance is the common terminology for the whole accounts- receivable finance sector. Factoring and discounting are therefore types of asset-based financing, covered by the umbrella term ‘invoice finance’ and they both share common principles.

    What’s the Difference Between Invoice Factoring and Discounting?

    The key difference between invoice factoring and discounting is that while invoice discounting allows the business to retain control of its sales ledger and invoice collection, factoring gives the invoice finance provider that role.

    Invoice Factors will manage their own credit control, and chase customers directly for the settlement of invoices.

    Some businesses may be concerned about the factor taking over the credit control for their business ledger, due to the relationships with their clients and customers. Some factoring companies will have very little contact with your debtors and can in some instances, provide a service to set up a separate bank account which they assume control of, and that is under your business name. If the factor does contact your clients or customers, they can say that they are your billing department to help keep relationships as intended.

    Summary
    With invoice factoring, the factoring company collects the debts and with invoice discounting, you retain control of that process.

    Can I Factor Invoices Selectively?

    Yes. This type of financing is called selective invoice factoring, selective invoice discounting, spot factoring, or single invoice financing. This is where you can pick and choose which invoices you wish to factor by selling individually selected invoices. This gives you the flexibility to choose the specific invoices that you factor.

    What is the Meaning of Reverse Factoring?

    Reverse factoring, also known as supply chain financing, is a finance solution initiated usually by a larger company who introduces a smaller one to its invoice finance provider.

    The invoices to the smaller company are then secured against the larger invoices of the bigger company. So it’s a case of a big company lending its financial security to someone they work with, securing the stability of its supply chain in the process.

    Currently, the process accounts for a small percentage of the overall invoice factoring market.

    What is Recourse Factoring?

    Recourse factoring is standard practice, unless otherwise specified, meaning if your customer doesn’t pay it becomes your responsibility to cover the cost.

    Non-recourse factoring is a specific product in it’s own right and is often referred to by lenders as ‘bad debt protection’. Bad debt protection protects your business from non-payment. There are circumstances where this is warranted, however, it comes with higher costs, as you might expect from the increased risk that the factor takes on.

    Is it Regulated in the UK?

    The invoice finance industry is not currently regulated by the Financial Conduct Authority (FCA).

    With this in mind you need to exercise due diligence with any provider you may choose, investigating the possibility of hidden fees which may not be immediately evident.

    It’s worth pointing out that regulation, should it arise in the future, would almost certainly increase the costs of factoring. FCA regulation costs between £1,500 and £50,000 per company who applies so these costs would inevitably get passed onto consumers.

    Summary
    Invoice factoring is not regulated by the FCA. Check for hidden fees with any prospective provider before committing to anything. Not being regulated may currently be helping to keep costs for this type of finance down.

    How Can a Business Apply for Invoice Factoring?

    Fortunately, there are many factoring companies in the UK and Business Expert has access to the whole market. We are the only funding platform to have an algorithmically controlled quote platform, allowing you access to your own tailored report after completion. We have several options to apply for factoring services, whether you are looking to factor your business’ invoices selectively, or you need a factoring facility to access funds, ongoing.

    If you think your business may benefit from a invoice financing please feel free to either use our free invoice finance platform (below) that gives you access to the whole market, fill out the quick quote form towards the top of this page, or just send us an email. Alternatively, you can use the love chat feature on this page, or call us anytime.

    FAQ’s

    How Much Does a Factoring Company Charge?

    On average, factors will charge 1.5 – 5 percent of the total value of the factored invoices, per month. Read more details about factoring charges on the Business Expert website..

    Is Factoring Invoices a Good Idea?

    While this is a commonly asked question, it depends on your particular business, and in particular your number of invoices and profit margins. Factoring works particularly well for businesses with good profit margins and a smaller number of invoices.
    Read more details about how factoring works on the Business Expert website..

    Do the High Street Banks Offer Factoring?

    Most of the well known banks do offer factoring although some are extremely cautious about taking on clients outside of their existing business customers. Use Business Expert’s free quote service to get quotes from a range of the top lenders.