Factoring or invoice discounting has become the most common way to fund working capital for businesses over the last 10 years.
We choose our words very carefully in the opening paragraph by choosing ‘common’ rather than ‘popular’.
Most businesses would prefer the traditional bank overdraft as there is less day to day management of the funding and the process by which advances are made can be confusing with invoice discounting or factoring. It is also perceived as expensive. One of the reasons it appears expensive is that the facility normally has to be managed daily by the funder which incur costs which need to be passed on.
Unfortunately there is little choice for a growing business other than to use invoice discounting or factoring.
At Seagrave French we’re used to helping clients project their cash flow where they’re using such funding and so we think we’re well placed to show you how to get the most of your factored funding.
The Basics of Factoring
Simply put factoring or invoice discounting allows a business to draw money on their debtors [customers who owe them money]. An advance rate is agreed with the funder and this is eligible to be borrowed with the debtors acting as security. When the debtor pays the borrowing is repaid and the surplus is paid to the business. An example may help here.
An Example of Factoring
Let’s assume the advance rate is 80% and we invoice our client £10,000.
Step 1 – We raise an invoice to our client and we upload the invoice to our factoring funders. They send us £8,000 against this invoice.
Step 2 – A few weeks later the client pays the invoice in full and these funds are sent to the factor. The £10,000 pays back the factor the £8,000 borrowed and they then return to £2,000 to the business.
It’s more complicated than this as there are many invoices being raised and clients paying their bills, but the following principal can be applied and this is our top tip number 1 and 2.
When you upload an invoice to the factor your cash will improve by the factor rate applied to the invoice [in the above example this is 80%].
When a customer pays you will receive the balance of the invoice amount paid [in the above example 20%]
In order to reduce the risk to the factoring company, they have rules to reduce the amount received. These can include:
- Invoices overdue by a certain number of days are not funded. So for example when an invoice is over 90 days old you have to return the amount advanced against it. There is normally a charge based on a percentage when the invoices go over aged.
- Your customers will be given credit limits based on their credit worthiness and the invoices are only funded to that credit limit.
- If a customer partly pays an invoice then the balance of the invoice will not be funded.
Because of these issues, the amounts advanced can become complicated to predict and often the cash received falls short of expectations. So it’s time for another tip.
Using the principals in tip 1 & 2 calculate each day what you think the advance available should be and if it isn’t try to find an explanation – the reasons could be
• Has a debtor gone over the ageing limit?
• Has a customer’s credit limit been changed?
• Has a customer partly paid?
• Has there been some unexpected charge?
It is possible to negotiate with the factoring company, and so it’s important to build up a good relationship with your day to day relationship manager.
Talk to your account manager regularly and don’t be afraid to challenge them if you think they’ve got something wrong or you don’t understand why your availability is not as expected.
Prevention Is Better Than A Cure
So there’s no need to panic when you look at your factoring account in the morning and it’s not what you expect, you can get things fixed when things go wrong. There are things you can do to prevent things from going wrong in the first place
Agree a standard credit limit for all customers that is in line with you average invoice amount, this will reduce a lot of unnecessary credit note breaches.
Upload new customer details as soon as they are known so that their account can be set up and if necessary negotiate a higher credit limit.
If a large piece of work is won for a new customer advise the factor and agree an increased credit limit in advance.
Review the impending disapprovals report early and identify customers that need more of a nudge to pay you before they go overdue.
Hopefully, you’re now a bit better prepared when it comes to dealing with your factoring or invoice discounting provider. If you’ve got any other queries about this or any other financial matter then please give us a call or drop us an email here!