Managing cashflow is crucial to keeping your business afloat. But with lending to small businesses not as forthcoming as it could be, invoice finance is becoming a more attractive option for many Small and Medium-sized Enterprises (SMEs).
Factoring and invoice discounting are two types of business finance that allow you to unlock the cash in your unpaid invoices so that you can pay your own suppliers, invoices and staff.
Factoring is where you sell your invoices to a finance provider who, in return, advances you a percentage of the value of those invoices – typically 85% to 90%.
The invoice finance provider can also manage and arrange for collection of the invoices.
Factoring can be a great way to unlock money and keep your business moving, but there are drawbacks to be aware of too.
Some factoring providers will offer a 'confidential factoring' service whereby your customers don't know that your business has sold its invoices to a third party.
You may be able to get "bad debt" protection included as part of the factoring agreement, although this will be more expensive than having no protection. The different options are:
This type of factoring means you get no bad debt protection. If a customer pays too late, or not at all, you have to pay back the money you have been advanced in full, together with any fees and interest.
Non-recourse factoring means that the factoring company shoulders the risk of bad debt. You don't need to pay back any money if a customer doesn't pay. This option is normally a bit more expensive than recourse factoring.
If you'd rather retain control over the management of your invoices, invoice discounting can offer a real alternative.
Invoice discounting is much the same as factoring: there are confidential options as well as recourse or non-recourse alternatives. However, invoice discounting is normally only available to established companies (although some may consider start-ups) and the minimum turnover requirements are usually higher, typically at least £500,000.
Invoice finance is for businesses whose customers are other businesses - retailers will not usually be considered by providers.
Increasingly, providers are prepared to consider start-up businesses. However, some may impose a minimum turnover, which can be anything from £50,000 upwards.
To be an attractive business for a factoring or invoice discounting provider, you should not be over-reliant on a single customer and should have a spread of invoices.
The invoice finance provider will normally look at your invoice book and may decline particular invoices (or your entire application) if you have several customers who are more than 90 days overdue.
You should only consider factoring or invoice discounting an option if you have few invoice disputes and have customers who pay reasonably promptly (within 90 days).
Disclaimer: This information is intended solely to provide guidance and is not financial advice. Moneyfacts will not be liable for any loss arising from your use or reliance on this information. If you are in any doubt, Moneyfacts recommends you obtain independent financial advice.
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