John Tinsley : Money Matters

Cash flow is crucial to the smooth running of a business. The yearly profit reports can be a good indicator of performance but the truth is that a company has to operate every day of the year and this means that money must be available at all times for paying employees, investing in stock and assets, and covering all overheads. In many businesses, cash does not come in totally smoothly every day or week in a uniform fashion and instead big payments tend to come in clusters with large gaps in between. This can affect industries such as manufacturing, construction, or even fast paced financial companies where ready availability of cash can make or break a tricky deal.

Invoice financing is a tried and tested method that has been in existence since the late Middle Ages and has a strong history of smoothing out cash flow. It has its origins as a method for traders to keep running in between shippings of goods, as there was often a very long time between payments. The tradition of invoice financing as an alternative to loans has continued to this day.

Invoice factoring uses the outstanding debts on a sales ledger to provide cash for a company. The financing company agrees to pay the business a certain percentage of the value of the debts, often up to 90 per cent. In return, the company takes control of the ledger and chases up the debts from the clients, receiving the full value and thus earning a profit. In addition, some factoring companies offer a financial processing service whereby they process the sales books. This can be extremely helpful for smaller companies who do not have their own established administration departments.

Financing using invoices is a relatively safe method since only outstanding payments can be used to create ready cash. In the case of invoice factoring, it can even help to improve profits by reducing accounting overheads. The downside is that clients will deal with the factoring company for payments, possibly altering client-business relations. For a service that does not involve this, use invoice discounting.

Invoice factoring will enable around 80 percent of the money on the company’s debtors list to be released up to 60 days before it is actually due for payment by its customers. This article is intended to explain some of the benefits of invoice factoring.

The first benefit is that you gain almost instant access to money you have already earned, without having to wait for the invoice to become payable and subsequently having to chase the customer for it. By borrowing the money you can keep cash flowing consistently through your business, which will keep it financially healthy. 

Secondly, you can usually borrow as much or as little as you need, depending on your company’s specific needs. Of course, the maximum available is dependent on the amount owed on the debtors list. You could choose to borrow less than this; the actual amount is down to you.

The third benefit of invoice factoring is that you do not need to waste time and money on credit control, chasing money owed from customers over the telephone or via email. This frees you and your employees get on with more important core tasks, such as increasing sales and growing the company.

A final great thing about invoice factoring is that absolutely no other assets are required in order to secure the funding. Invoice factoring gives you easier access to cash than approaching your bank and asking for a traditional loan.

When a business chooses a factoring company it can expect to pay factoring costs in the form of a fee or a commission for performing the agreed upon credit and collection services. Typically, the commission or fee is between 0.1% and 0.3% of the sales.

What determines the factoring costs charged to a business are numerous and noteworthy. First, the very nature of the business, including seasonal elements, product stability, market sector (wholesale or manufacturer) and styling considerations, is the single most important element in establishing factoring costs.

Sales volume is another aspect examined for determining factoring costs. Factoring applies a sliding scale based on annual sales volume of the client and percentages decline as volume increases. Sales volume per customer also affects the percentage. The more concentrated the customer base, the smaller the percentage because there is less work and follow-up with fewer customers.

Size of orders can predetermine some factoring costs. The profit margin of large orders filled over the same time as it would take to process a small order is significant; fees can be lower with larger orders from the customer base.

Other factors such as client credit worthiness, selling terms and billing practices can affect the fee or commission charged by the factor for factoring costs. If selling terms are long and the credit is substandard, the fees will rise in accordance with risk.

Moreover, factoring companies do charge interest for funds disbursed. It is generally a rate above the base rate established by the Bank of England.

Selecting a factoring company that is suited to your business is undoubtedly crucial both for your business and your peace of mind.  There are so many service providers available to you, including independent factoring companies, subsidiaries of banks and other financial institutions.  As you will want to make the most informed choice available, investing some time studying the market and identifying what your company needs most from your factoring partner is imperative.  

First and foremost you should be reassured that the factoring company has a detailed knowledge and experience within your sphere of operation.  Many factors seek to provide specialist services for particular markets and it is important that the company you choose can operate effectively within yours.

Many factors wish to set monthly minimum transactions, ensuring that they will have a certain volume of invoices presented to them.  This procedure is fine in theory and will normally attract better terms for your company.  However, if there is a dip in sales then you may be liable to make up the cost.  Finding a provider who does not insist on minimum transactions might be better for your company.

Fee structures can vary greatly across the industry and shopping around will prove most beneficial.  Many fee structures are complex and a company providing a transparent fee structure is preferable and avoids any potential for disputes.

Perhaps the most crucial aspect when selecting a provider is finding the factor that provides the services most appropriate to your specific needs.  You might want to balance the cheaper cost of a company who takes a more impersonal mass approach to one that might be slightly higher in cost but holds a more inclusive ethos.

Cash flow within a business can sometimes be problematic, especially when money is tied up in invoices for work that you are waiting to be paid for completing.  Factoring, or debt factoring, as it is commonly known, can help with freeing up this cash in order for it to be injected back into the business as soon as possible. 

The practice of debt factoring, fundamentally, is the process of selling one’s invoices to a third party.  When a business completes a piece of work or provides a service, it can often take time for them to be paid and this occupies money that may well be needed, often sooner rather than later.  Debt factoring helps to release this money much more quickly into the business so it can be used as needed.  A lot of businesses prefer this approach in comparison to relying on a business overdraft as it can be easier to organise and there is no definitive limit to the amount that could be borrowed.

As well as being useful to a business by helping to release funds more rapidly (usually within 24 hours), it can also help cut administration costs.  The debt factoring company can provide a further support service, meaning they can chase invoices in order to procure further payments, saving you the hassle of having to do so.  They can also supply insurance cover, protecting you against payments that are not received, meaning that you will still obtain the balance.

A recourse factoring agreement is where the factor agrees to advance funds against outstanding invoices but the credit risk remains with the client.  In the event that a company does not, or cannot pay its outstanding debt, the factor will return to its client for reimbursement of the value of the invoice.  In its simplest form, any bad debt will be reclaimed by the factor from the business that produced the invoice.  The initial factoring agreement will clearly specify the amount of time after the invoice should have been paid that the debt returns to the invoicing business.  On top of the reimbursement of the debt to the factor, the company will also remain liable for fees and any interest on the invoice. 

In the event of a non-paid invoice, the invoicing company must provide funds or an alternative credit worthy invoice to the factor to cover the amount outstanding.  The amount must be equal to the invoice originally sold to the factor or to the percentage agreed, if such negotiations were conducted during the contract agreement.

Recourse factoring is the cheaper option within invoice factoring solutions as the business holds the risks associated with bad debt and therefore reduces the risk of loss to the factor.  It is also likely that the factor will advance a higher amount against the invoice and charge a lower fee once the invoice is collected.  As the risk to the factor decreases, the fees and rates charged tend to be adjusted to reflect the relative positions of risk.

As with any business, one of the most important aspects is cash flow.  There always needs to be an available balance of cash that can be used to purchase essentials for the business, in order to keep it going.  Without this cash flow, the business could grind to a halt and be unable to keep trading or produce its product.

Cash Tied up

Many companies will be unlikely to see any form of payment on invoices for at least 30 to 60 days.  This means that cash is tied up until the invoice is paid.  By using this type of financial service, it allows the cash that is otherwise tied up to be released for use in the operation of the business.

How it Works?

The basic principles of invoice factoring are that the financial company will exchange the outstanding invoices that are awaiting payment for cash.  The value of the invoice awaiting payment will usually be paid at around 80% to 90% of its value.  Then as the invoices are due for payment, the financial company will collect the outstanding balance of the invoice in full. 

What to Look For

When it comes to an invoice factoring service, three main areas are looked at, invoice payment dates, customer credit worthiness, and the factored volume per month.  It is the difference in how much of the invoice is received as cash against the total amount of the invoice.  This difference will be the charge for the service so making sure that as much of the invoice amount is received as possible will mean a lower charge.