Invoice factoring, or accounts receivable factoring, is the simple process of using a third party to collect outstanding invoices. In doing this, the third party will release the majority of the owed money to you straight away before collecting payment from your customers.
In practice, you are releasing up to 90% (depending on the company) of unpaid invoices, giving you immediate access to working capital. The factoring company would then take a percentage of the total invoice, with the remainder being paid to you after collection.
This post will give you more information on the different invoice factoring options available and look at the advantages and disadvantages of this option for your business.
Invoice Finance Explained
Having access to this capital as and when you need it can help with the running of your business by reinvesting in growth, paying suppliers, and paying employees.
This gives you a quick, flexible, and relatively low-risk way to access money. To provide you with a better idea of whether this is the best financial option for you, we’ll be looking at the advantages and disadvantages of invoice factoring and answering all the questions you may have.
Advantages of Invoice Factoring
To ensure you have everything you need to make an informed decision about your business finances, here are the most significant advantages of using invoice factoring companies.
Immediate working capital
Having immediate access to money will help your business run smoothly and allow you to make necessary payments or invest further in the operations of your business.
Business loans can take time to be arranged, approved, and deposited. Invoice factoring solves any immediate cash flow problems quickly.
In some cases, funding can be pushed through on the same day. It is ideal for businesses that;
- Need emergency access to capital
- Have short term financing needs
- Don’t have time to wait for customers to make their payments.
This can be a regular arrangement
If you need regular access to working capital, you will build a relationship with your factoring company and use the service to guarantee ongoing cash flow.
Not having to wait for your invoices to be paid will allow you to benefit from using the capital as and when you need it.
More chance of approval than with business loans
If you’re looking for a business loan to access capital, your credit score, loan history, and collateral will all be under scrutiny. You might have invested a lot of time in your application only for it to be turned down.
With invoice factoring, the factoring company will be more interested in your customers’ payment history to ensure they will be able to recoup the money.
This makes it ideal for companies that may have had financial difficulties in the past or that have a low credit score.
Contacting customers and keeping track of outstanding invoices can be a big job. Outsourcing this task and concentrating on the day-to-day running of your business can save you a lot of time, which can be spent on other tasks.
Keeping contact with customers positive
Nobody likes being chased for money – and nobody likes doing the chasing. Constantly having to contact customers can start to sour the relationship.
If this responsibility is passed onto a factoring company, you’ll be able to concentrate on the positive aspects of your business relationships.
Disadvantages of Invoice Factoring
There are inevitably disadvantages to invoice factoring, and we would be remiss not to mention them. Understanding every aspect of any financial agreement is crucial to choosing the right one to suit your business.
You will pay the factoring company a service fee, typically around 1-5% of the total invoice amount. It’s up to you to decide whether the cost is worth the service.
You may be responsible for any invoices that the invoice financing company is not paid. They are not debt collection agencies, so you must have a good relationship and trust that the customer will pay.
Liabilities will be covered when signing up to any invoice factoring agreement.
Approval depends on the customer history
Though it is an advantage that your business credit history will not be a factor, your customer must have a history of paying on time; otherwise, the factoring company may reject the invoice as being too risky.
You will provide the factoring company with your financial information
Because you are handing over control of your invoices to the factoring company, you will have to ensure you are entirely comfortable with their practices.
There should not be any issues with reputable factoring companies, but researching them should be a priority.
It may affect your reputation
Building up good customer relations takes time and effort. Suddenly transferring invoices to a third party may not sit well with your customers.
You will lose some aspects of client communication, and they may question why you are handing over your credit control to a third party. They may think this reflects poorly on either them or you.
The Different Types of Invoice Factoring
Invoice factoring comes with many choices. Understanding what options are available to you will help you to make the right decision.
Recourse factoring makes you liable for any invoices that are not recovered from your customer. This type of arrangement removes the risk for the lender but still allows you to access funds when you need them.
If you factor an invoice valued at £10,000 and your customer defaults with recourse factoring, you would then have to repay the £10,000.
Recourse factoring is the most common factoring arrangement on the market, making up around 90% of active deals.
Non-recourse invoice factoring
Non-recourse factoring arrangements are when you would not be liable for any defaults on debt from your customer.
This kind of arrangement is much rarer than a recourse factoring deal due to the factoring company shouldering the risk of unpaid invoices. Due to the risks involved, the invoice factoring company is more likely to charge a higher factoring fee.
Selective invoice factoring
Selective invoice factoring, or selective invoice discounting as it is sometimes known, allows you to pick and choose which invoices you finance, giving you much greater control.
This is great for businesses with trusted clients and customers who will pay invoices in the payment window. The downside to this is that you will be required to have some form of internal credit control in place, making it a less feasible option for contractors and sole traders.
Spot factoring allows for individual invoices to be financed. This arrangement is suitable for emergencies rather than being used regularly as it can prove one of the more expensive options.
Debt factoring works much the same way that invoice factoring does. The main difference is that the money is loaned against the owed invoice with invoice factoring. With debt factoring, the invoice is bought from the company.
Reverse factoring would come from the buyer. They would go through the third-party invoice factoring company who would release as much as 100% of the invoice to the supplier. The buyer might choose this option as they will negotiate with the factoring company at a suitable time to fulfil the invoice.
The supplier would be contacted before this goes ahead as their agreement is necessary. This is still a financing arrangement, the only difference being who sets it up.
Invoice Finance Companies That Offer a Factoring Service
We’ve already answered some of the main questions like ‘what is invoice factoring?’ and ‘how does invoice factoring work?’ The next thing to determine is which companies provide a factoring facility. Here are some of the top UK invoice factoring companies you’re likely to come across.
Hitachi Capital (UK) Plc
Hitachi Capital UK has been around since 1982 and is recognised for its high levels of customer service.
You will be able to take advantage of short term contracts to decide whether the service suits your business needs.
This innovative service is a member of the Peer-to-Peer Finance Association and allows invoices to be ‘bought’ by several buyers, much like crowdfunding.
The online platform is available 24 hours a day, has fees of between 1-3% and does not require a contract. This flexible option does not have any hidden fees and is ideal for businesses watching their costs.
Bibby Financial Services
Bibby Financial Services are one of the biggest invoice factoring providers, ideal for small and medium-sized enterprises and large corporations in the UK. They have 19 offices throughout the UK and Ireland and count over 7,000 businesses on their books.
They have extensive experience in dealing with a wide and varied customer base.
RBS Invoice Finance
If you’re looking for a big name, there aren’t much more prominent in the UK than the Royal Bank of Scotland Group.
RBS Invoice Finance are one of the biggest UK factoring companies and offer a raft of services, including their online factoring management platform, Facflow.
IGF Invoice Financing
For a flexible service tailored to your business needs, IGF Invoice Financing offer services that can grow and adapt to your business.
Close Brothers Invoice Finance
Close Brothers Invoice Finance offers an award-winning factoring service to medium and small businesses that consider your industry, turnover, and business objectives.
Aldermore Invoice Finance
Aldermore Invoice Finance offer a straightforward service with transparent fees – they’re recognised as one of the UK’s leading factoring companies.
GapCap offers a speedy solution to cash flow problems, with most applications receiving offers within 24 hours. Businesses with a trading history of over six months are eligible, and with a strong Trustpilot rating, it’s clear that they’re well regarded by their customers.
Optimum Finance is ideal for startups due to them having no minimum turnover requirement. They offer bespoke solutions and access to an online system to monitor your finances. A debtor protection option is also an excellent option for businesses looking for peace of mind.
Invoice Factoring FAQs
Why use a factoring company?
The main reason that companies take advantage of factoring is to ease cash flow concerns. Invoice factoring allows businesses access to working capital within 24 hours. Customers can take anywhere from 30 to 120 days to pay, and business loans can be difficult and time-consuming to get approved.
Borrowing against money that is owed to you allows you access to funds with minimal risk.
Is invoice factoring the same as a loan?
Invoice factoring, or accounts receivable financing, is not considered a loan. Rather than paying interest as one would with a loan, a factoring fee is taken from the remaining balance paid to the business.
How is invoice factoring regulated?
While invoice factoring is not regulated by the Financial Conduct Authority (FCA), there is an industry-wide code of practice provided by UK Finance.
UK Finance maintains the integrity of invoice factoring services and ensures a fair service is provided.
Regulating the sector would lead to an increase in costs which would then be passed on to customers. Self-governing and adhering to the principles set forth by UK Finance ensures a high-quality service can still be provided at competitive prices.
Why should I use a factoring company?
All financial decisions for businesses should be thoroughly researched to ensure it is the best decision moving forward.
Invoice factoring is a viable option for businesses that need to free up working capital to make payments, pay employees, or invest in operations.
Invoices usually take between 30-90 days to be paid. In some cases, this can be 120 days. Having access to these funds can help businesses with temporary cash flow issues.
How much does invoice factoring cost?
Invoice factoring costs will differ depending on the invoice value and the terms agreed with your factoring company. Charges will be split into three main areas:
- Set up fee – The set-up fee covers administration costs for setting up the facility.
- Service fee – The service fee covers the ongoing management and administration costs associated with your account.
- Finance fee – The finance fee will be a percentage of the invoice you pay for the service.
You must discuss all fees with your factoring company before agreeing to an arrangement. Other costs that may be involved include application fees, credit check fees, and mailing fees.