Factoring (also referred to as debt factoring) a term you might have come across if you’re looking to see what the market can offer in terms of funding options. Often also called invoice factoring, it’s a form of invoice finance that’s designed to help businesses with their cash flow. Let’s take a look at the essential bits of information you need to know about this potentially useful finance facility.
In this article:
- How does factoring work?
- Who is factoring for?
- What are the alternatives to factoring?
How does factoring work?
Unlike a loan, factoring is an ongoing financial agreement that is used day-in, day-out, and takes the form of lots of smaller loans. The process goes like this:
- A monthly fee is payable to keep the facility running.
- You raise an invoice, just like normal, but the amount is payable to your factoring partner.
- Within around a day of you raising the invoice, your factoring company will pay you most of the value of the invoice.
- The proportion depends on a few factors, but it’s usually between 80% and 90%.The customer pays the invoice to the factoring company, who will be responsible for credit control and collections.
- Once the full invoice has been cleared, the remainder of it is paid to you, minus any interest.
Who is factoring for?
Factoring is not a catch-all solution for businesses that need funding help. It’s designed for companies that are looking to overcome two primary challenges:
- They are struggling with cash flow (or they would like it to be better)
- Cash flow problems due to invoices being paid late, or potentially not at all.
Compared with other types of invoice finance, factoring is also chosen because it gives credit control over to the finance company. This means that a business no longer has to worry about collecting invoices or issuing lines of credit.
What are the alternatives to factoring?
Factoring is of course just one of many different funding options. It’s also just one type of invoice finance. There are actually quite a few different invoice finance products, which are tailored to different business needs.
Discounting for example works very similarly to factoring, but it’s a confidential facility that means your invoices won’t know that you’re using outside help for your invoice management.
Outside invoice finance, there are few direct alternatives to factoring, but any other product that is designed to help with cash flow could be considered when you’re deciding what’s best. As always however, consulting an independent financial adviser is always a good idea.