Invoice finance is an option that allows a small business to turn sales invoices into instant cash. The factoring company purchases the debt and immediately provides around 90% of the sales invoice to the business.
They'll then collect the monies from the company's customers and pay the balance, less fees, to the company concerned. There are two types of invoice finance: invoice factoring and invoice discounting.
Factoring is a flexible method of funding the working capital requirements of a company. The business submits copies of their sales invoices to the factoring company that pays an agreed percentage of the value of the invoices as instant cash.
The percentage available is normally up to a maximum 90% of the sales invoices dependent on a number of things including the type of industry and strength and spread of customers.
The factoring company maintains the debtors on behalf of the business and will contact the business's customer base for payment of the invoices if and when they become overdue.
When a customer has paid the debt to the factoring company, the business receives the balance of the invoice less the factoring company's charges and fees.
The main benefit of factoring is in its flexibility. Unlike more traditional forms of finance, the amount of funding available is directly linked to sales generated. Therefore, additional finance is always available to meet increased sales.
The two fees involved with factoring is a commission and interest paid. The factoring company's commission is normally between 0.5% to 2.5% of the sales value (less any early settlement discounts). Interest gets charged on the amount of funds advanced from the sales invoices at 2.5% over base rate.
Invoice discounting is virtually the same as invoice factoring, but the business customer doesn't know that a third party is effectively collecting the debt, i.e., it's confidential. It works in exactly the same manner where up to 90% of the sales invoice gets advanced by the factoring or discounting company up front, and the fees are similar.
Advantages of Invoice Finance
- The business gets instant access to cash from their invoices.
- You can get to 90% of sales value normally within 24 hours of passing the debt to the factoring company.
- The sales process is outsourced leaving time to manage the business.
- More likely to receive the monies from invoices.
- Don't need overdraft facilities or bank loans.
Disadvantages of Invoice Finance
- There are charges to pay to the factoring company to collect the monies (between 0.5% and 2.5%).
- A third party will contact your customers rather than yourselves.
- The factoring company may have a tough stance to collect the debt.
- The factoring company may outsource their collection facility.
- Your customers may interpret a factoring company means your business is in trouble (although this is generally not the case).
Things to check in Contacts with Factoring Companies
- What are the minimum charges?
- What is the length of contract?
- Are there any exit penalties?
- Is there a trial period?
- Check the reputation and obtain any client references.
- Financial strength of the invoice finance company.
- Check all additional fees such as auditing fees, bank transfer fees, bank charges, etc..
Invoice Discounting and Factoring Companies
There are many factoring companies and factoring brokers in the marketplace. Here are a few to check out although we recommend you do your own research before entering into any agreements.