Did you know that nearly 2 in 5 SMEs in the UK used external finance in 2022? The share of lending frameworks is hard to calculate but nonetheless, it includes bank loans, equity financing, trade credit and invoice factoring.
This article goes a bit deep in the invoice factoring realm – the silent factoring. Let’s find out more about this process.
What is silent factoring?
Silent factoring (confidential invoice factoring) is a type of financing where a business sells its accounts receivable to a factoring company in exchange for immediate cash. But unlike traditional factoring, the key aspect of this type of financing is the business’s customers are not informed about the involvement of a factoring company.
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Key aspects of silent factoring
Confidentiality: Customers remain unaware that a third party is involved in financing, allowing the business to maintain its relationships.
Business-controlled collections: Unlike traditional invoice factoring, the business continues to manage the collection of receivables. This gives them more control over customer interactions.
Higher costs: Due to increased risk for the factoring company, silent factoring may come with higher fees compared to normal factoring.
How silent factoring works
There are 3 parties involved in the process of silent factoring.
- Business: The business selects invoices and collects payments from the customers. It must ensure that customers are unaware of the factoring arrangement.
- Factoring company: Provides the advance and handles the final settlement while maintaining confidentiality.
- Customers: They continue their relationship with the business and make payments by the due date.
The actual process is simple – the business provides the product to its clients and requests an advance from the factoring company at the same time. The factoring company purchases their invoices at a discounted rate and advances a large percentage of the invoice amount.
Then, the business continues to collect payments from its customers, either routing them through a special account controlled by the factoring company or directly and when that process is completed, the factoring company receives the complete payment. They deduct their fee from this and release the remaining balance to the business. Silent factoring is pretty much the same as invoice finance.
Silent factoring vs Traditional invoice factoring
| Feature | Silent Factoring | Traditional Factoring |
|---|---|---|
|
Also known as |
Confidential or undisclosed factoring |
Disclosed factoring or just invoice factoring |
|
Is the customer informed |
Not informed |
Yes, the customer pays the factor directly |
|
Payment Flow |
Customer > business > factor |
Customer > factor |
|
Risk for business |
High |
Lower |
|
Cost |
Higher |
Lower |
|
Customer relationship |
Excellent, since customer does not interact with the factor |
Can take a hit since customer knows the invoices are factored |
|
Recourse |
Yes, the business bears the risk of non-payment |
Can be with or without recourse |
|
Admin cost |
High, since the business handles payments |
Low, since the factor handles payment collections |
Silent factoring costs
The major cost associated with silent factoring is the factoring fee. The factoring company delivers 70%-90% of the value of the total factored invoices, called the ‘advance rate’. In exchange for providing upfront funds, it charges 5%-10% of the invoice value to the business.
The percentage of the factoring fee is higher in this case because the factoring company is not directly in contact with the customers. That is why the invoices are deemed high risk as compared to traditional (overt) factoring.
The service fee for evaluating the credibility and creditworthiness of the invoices is often included in the factoring fee, otherwise charged separately. Other costs for silent factoring are contract-related and depend on the specific provider you work with. For example, some include a penalty fee in their contract terms, which makes it difficult to terminate the contract before its duration.
Silent factoring: Pros & Cons Summary
| Pros of Silent Factoring | Cons of Silent Factoring |
|---|---|
|
Preserved customer relationships |
Higher costs compared to traditional factoring |
|
Access to flexible cash flow |
Business is liable for customer payments |
|
Manage business operations efficiently without delay |
|
Benefits of silent factoring
- The customer relations are preserved: The biggest advantage of silent factoring is its ability to keep the factoring arrangement confidential. This discretion ensures that your customers continue to view relationship with your business as direct and unaltered. It aids in maintaining strong connections and prevents any potential concerns they might have about your financial stability.
- Cash flow becomes flexible: Since the factoring arrangement is not disclosed to customers, businesses have greater control over their financial strategies. They can choose which invoices to factor based on immediate cash flow needs, for example.
- Access to quick cash: It’s a swift way to access working capital without disrupting day-to-day operations. The process is streamlined in the UK, with the factoring company providing an advance on selected invoices shortly after the agreement is finalised. This quick cash can be used to fill payroll, manage the supply chain and overcome other expenses.
Drawbacks of silent factoring
- Higher costs compared to traditional factoring: And why is that? Because of the confidentiality and the reliance on the business to accept payments. Factoring companies may charge a high factoring fee for the extra risk they undertake by not notifying customers. These costs can add up and eat the profit margins of the business.
- Potential risk if the customer defaults: Since the factoring company is unaware of the customer’s involvement, they rely entirely on the business for repayments. If a customer fails to pay, the business remains liable for the amount advanced by the factoring company. This can create a financial strain, especially if multiple customers default.
Silent factoring vs other financing options
When considering financing options, businesses must weigh the benefits and drawbacks of each to find the best fit for their needs. Traditional factoring has both pros and cons and the same is the case with silent factoring.
1. Silent factoring vs traditional factoring
Silent factoring and traditional factoring both involve selling unpaid invoices to a factoring company, but they differ in how openly they handle the transaction. Traditional factoring is more transparent, with customers notified their invoices have been factored. This visibility can sometimes affect client relationships as well.
In contrast, silent factoring keeps the transaction secretive in an effort to maintain customer trust. Also, note that traditional factoring involves the factoring company getting the payments from the customers and not the business.
Learn more about the top UK invoice factoring companies.
2. Silent factoring vs invoice discounting
The primary difference lies in the level of disclosure and control. With invoice discounting, businesses retain control over the collection process and manage customer interactions directly, however, customers are aware that their invoices are being discounted.
In silent factoring, the customers are kept away from this fact.
Read in detail about invoice discounting and how it works.
3. Silent factoring vs bank loans
Bank loans provide a lump sum of capital with fixed repayment terms, which can be beneficial for long-term financial needs. But it comes with a lengthy approval process and harsh credit requirements.
Silent factoring is usually more accessible and faster to arrange. However, the costs may be higher than those of the loans.
How to choose the right silent factoring company?
The UK’s financing industry is crowded, and it can be hectic to sift through all the available options to ensure you make the right choice. That is why we have listed important factors that you should consider when choosing a provider:
Is the provider experienced in offering silent factoring?
Most providers prioritise working with businesses for traditional invoice factoring services for several reasons. It is considered lower risk than silent factoring, and statistically, most businesses seek it out more. Even if a factoring company claims to offer it, they might not have the experience to deliver top-notch services. That is why it is important to search for a transparent provider specialised in silent factoring with 3+ years of experience at least.
What are the general contract terms of the factoring company?
Before getting into any deal with the factoring company, you may ask about their contract terms and regulations. Focus on evaluating these points:
- What are the minimum and maximum durations of contracts offered by the company? An ideal provider should offer a range of options from 6 to 36 months, giving you a variety to choose from.
- Is there a requirement to factor a minimum number of invoices? This is an important element, especially if you have a few chosen invoices to sell.
- What is the advance rate offered by the factoring company? The exact amount depends on the volume, value and creditworthiness of the invoices. But generally, the provider should be able to offer 70%-90% of the invoice’s value.
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FAQs
A business should consider silent factoring when it wants access to quick cash without affecting its relationship with the customers. It involves industries that run on customers’s trust, e.g., legal firms, health industries, and high-end retail.
Before choosing silent factoring, consider the fee compared to traditional methods, the impact on cash flow and the terms of the factoring agreement. Assess whether maintaining confidentiality justifies the expense.
Yes, silent factoring can be used with international clients. However, it’s essential to ensure that the factoring company has the capability to handle cross-border transactions and understands the specific regulatory nuances of the countries involved.
