A factoring company specialises in invoice factoring (also known as debt factoring) and provides funds to companies against their unpaid invoices.A factoring company buys accounts receivable (invoices) from businesses and releases up to 90% of the invoice amount in as little as 24 hours. By opting for debt factoring, businesses don’t have to wait for customers to pay; hence, the cash flow doesn’t get disrupted. In the meantime, they can use the invoice funds from the factoring company to resume their business dealings.
How does a factoring company work?
The factoring company pays a large portion of the invoices up-front (typically 70-90%) while the remainder is paid (minus fees) once the invoice amount is collected in full. The factoring company is an expert in collecting and managing invoice payments from customers so you can focus more on your high-leverage tasks. It takes responsibility for collecting payments from the customers.
Why use a factoring company?
Working with a factoring company appeals to a lot of small to major businesses that struggle with cash flow problems. If you are not an SME, but your business has long payment terms with your client, you can still benefit from working with a factoring company.
If your business is not any of the above and you just need cash assistance, but your business does not qualify for a traditional bank loan, you would want to opt for the invoice factoring option. The probabilities are endless.
Companies use invoice factoring for multiple reasons like:
- Quick capital access
- Flexible qualification
- No physical collateral is required
- Saves time and resources
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What businesses can work with a factoring company?
The only baseline requirement to secure invoice factoring funding is that your business must have outstanding invoices. Beyond this, all types of businesses can work with a factoring company. Whether you are a young startup, a one-person team, an SME, or a large corporation, there is always a factoring company out there with experience in your industry sector.
We have provided a list of the most common industry sectors that can secure invoice factoring in the UK:
- Manufacturing
- Transportation and Logistics
- Staffing Agencies
- Wholesale and Distribution
- Oil and Gas
- Retail
- Construction
- Healthcare
- Professional Services
- Technology and IT Services
Easily qualify for factoring
Qualifying for invoice factoring is not a difficult or complex process. It is easier than taking a traditional loan from a bank. A lot of times a factoring company gets mixed up with a bank, which is not true. Both financial institutions have different standards to asses businesses to provide them with funding.
Banks provide loans and assess your credit history, credit score, assets, and more to gauge your financial management. In contrast, a good credit score may not be necessary for invoice factoring because factoring companies purchase your future invoices. Even businesses with bad credit scores may work with a factoring company.
How much does factoring cost?
There is no standard cost of factoring in the UK, as fees can vary widely based on a range of factors, including:
Reliability and performance of the business – A high turnover indicates the business is performing well and results in better discount rates for factoring. Many factoring companies want you to be trading for at least 6 months to a year and have a minimum turnover to ensure that your business is reliable.
Client’s creditworthiness – The creditworthiness of your clients directly impacts factoring costs.
Niche & industry of the business -Different industries might have different levels of risks associated with non-payment of invoices.
The volume of invoices you are factoring – Factoring larger volumes of invoices usually leads to lower rates because it reduces the risk for the factoring company.
Breakdown of factoring costs
To give businesses a clearer understanding of what to expect from a factoring company, here is a breakdown of the typical costs associated with factoring:
1. Discount rate
The primary cost of factoring is the discount rate, typically ranging from 1% to 5% of the total invoice value.
2. Additional fees
Apart from the discount rate, additional fees might apply. These can include setup fees, service fees, processing fees, or fees for credit checks on your clients. Be sure to inquire about any potential hidden fees before signing an agreement.
3. Creditworthiness and terms
A factoring company considers the financial reliability of your clients to decide the cost of factoring. This is to see whether your clients are reliable enough to pay the pending invoices. Clients with better credit might have lower rates. Moreover, longer payment terms could also affect the cost, as the longer an invoice remains outstanding, the more you’ll pay in fees.
4. Volume & duration
Some factoring companies might offer volume-based discounts or adjust rates based on the duration in which an invoice remains unpaid.
Some factoring companies might offer volume-based discounts or adjust rates based on the duration in which an invoice remains unpaid.
How does a factoring company make profit?
A factoring company makes its profit by charging its customers with a discount rate (as mentioned in the cost breakdown previously). When a business gets into an agreement with a factoring company, it receives 90% of the unpaid invoices. After collecting all the unpaid invoices from the customers, the factoring company pays the remaining 10% of the invoice funds to the business minus the 1%-5% of its fee. That’s how a factoring company makes a profit with its business model.
Factoring company vs a traditional lender
A factoring company is different from a traditional lender in numerous ways. A factoring company doesn’t provide a loan; instead, it buys the unpaid invoices and takes control of them. Additionally, a traditional lender like a bank conducts a credit check on a business before granting the loan and this can affect the business’s credit score. In contrast, a factoring company doesn’t conduct a strict credit check of the business. Instead, it reviews the credit score of the customers to see how consistently they have been paying their invoices. This means, working with a factoring company also doesn’t impact your credit score.
However, in some cases like invoice financing or recourse factoring, the responsibility of collecting the unpaid invoices falls on the business. If it fails to do so, the risk of nonpayment is incurred for the business and not the factoring company. In such a scenario, the business’s credit score could be negatively impacted.
Choosing the right factoring company
There are a lot of options when choosing a factoring company for your business. So how do you know which factoring company is reliable? We have compiled a list of 5 questions that you can ask yourself before making the final decision :
How many years of experience does the factoring company have?
This is to make sure the company is reliable. If the company has been in business for a long time, this is a good sign because it means they have been consistent in their services to be able to still run their business.
What is the advance rate?
The advance rate is the percentage of the invoice value that the factoring company will pay at the start of your contract. Usually, this advance rate is somewhere between 70% and 90%. The higher the advance rate, the more cash you’ll receive.
What are the terms of the contract?
This question is important because you wouldn’t want to be stuck in a long-term contract without even knowing it. Ask if there’s a penalty for ending the term before it ends.
Does the factoring company require a minimum volume of invoices?
Some factoring companies don’t work with you if you have a small number of invoices. A lot of times, they require a minimum number of invoices For small businesses, this can become a problem if your sales volume fluctuates a lot.
How do they deal with customers to handle collections?
Look into the reviews of the factoring company from previous businesses they have worked with. Learn about their process for dealing with unpaid invoices and how they communicate with your clients. Their collection practices must be professional to maintain a good image of your business
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FAQs
Factoring companies are different from traditional banks because they purchase your pending invoices instead of providing you with a loan. So you do not undergo a debt, and it does not impact your credit score negatively.
You have to qualify for a bank loan; however, you don’t need to do that to work with a factoring company. You can be eligible for invoice factoring even if you don’t have a good credit score.
If your company deals with late client payments a lot and you think that it largely affects your revenue flow. Then you should go for invoice factoring, as it can be a good financial strategy for your business
Yes, a factoring agent is just another name for a factoring company. The factoring company buys your pending invoices and provides you with cash in exchange for them. This cash is called the advance rate, and it is usually worth 70% – 90% of the invoice’s value.
It’s hard to compare factoring terms since there is a lot of competition and there are no standard factoring terms. But, a good way to compare them is to look at the discount rate.
For example, if one company gives you 80% of your invoice money at once but charges 2.5% of the total invoice as their fee and another company offers 85% upfront with only a 2% fee, the second company might be the better choice because they give you more money upfront for a smaller fee.
