Factoring & Invoice Discounting

Factoring

Factoring involves selling invoices to a third party. In return they will process the invoices and allow loans to be drawn against the money owed to the business. It is commonly used by companies to improve cash flow but can also be used to reduce administration overheads. Companies that supply this service are called factors or debt factoring companies. The factor buys the invoices that the business raises on normal credit terms – 14, 30, 60 or 90 days. The factor will then remit, normally within 48 hours between 70 and 85% (depending on the agreement you have) of the VAT inclusive value of those invoices. This is normally done by simple bank transfer giving immediate access to working capital, to help finance the business. This payment is normally referred to as a “prepayment”, “drawdown” or “initial payment”. As part of the factoring service, the factor will administer the sales ledger, issuing statements and following up with chasing phone calls and letters. Most factors will allow some input and flexibility on how this is done, ensuring goodwill is maintained with customers, whilst still collecting the money in an efficient manner. When the customer pays the factor, the balance of the money (the difference between the prepayment and the full value of the invoice) is passed back to the business. A form of factoring exists which will protect the client, in the event of the failure by the customer to pay for reasons of receivership or insolvency.

Invoice Discounting

Invoice discounting offers the cash flow benefits that factoring offers but without the need to transfer control of the business’ sales ledger and existing methods of credit control. It is usually (but not in every case) a confidential service (known as “C.I.D”- Confidential Invoice Discounting or “D.I.D.”- Disclosed Invoice Discounting). Factoring companies usually look for well-established, profitable businesses with an effective and professional sales ledger administration system before they are prepared to offer this form of facility. Generally turnover needs to be running over £500k (and with many factors £1m) to qualify. Service charges (often known as “commission charges”) are usually much lower than for factoring for the obvious reason that the sales ledger administration is still the responsibility of the client. Discount charges vary from case to case but are generally between 1.25% and 3% over base rate. Often a discounter will try to match or beat the rate currently being charged by the client’s bankers. This method of finance is becoming an increasingly popular method of financing mergers and acquisitions, MBO’s and MBI’s. Invoice Discounting is increasingly used alongside stock finance, term loans and trade finance to offer a full asset based lending package.

Different Types:

Recourse: If a customer fails to pay an invoice, the factor will look to the client for reimbursement of any amounts advanced against the invoice. The service excludes bad debt protection.

Non-Recourse: If a customer fails to pay an invoice, the factor will pay the client. They pay an additional charge to cover the credit insurance costs.

Agency: A service which enables the client to retain the collection function, but which is disclosed to the debtor

Confidential: A factoring arrangement whereby the debtors are not notified of the assignment to the factor. The client collects the debts as agent for the factor.

Export Financing: A factor who provides export funding for his clients.

Disclosed: A disclosed invoice discounting service will be (as its name suggests) disclosed to your customers. Invoices will carry a notification of the involvement of the lender.