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Every year without fail usually around the beginning of January I would get the annual visit from my bank manager, although over the years I thought he began to turn into a salesman.
Amongst the usual subjects that we talked about, like the size of next years overdraft, was the subject of Factoring or Invoice discounting. I was never really aware of the difference but I am now and I’ll do my best to explain it in a minute.
Both are similar ways for businesses, with a number of slow payers, to get some of their cash upfront as soon as they raise the invoice. As you will no doubt be aware this does not come without some cost.
The Basic Idea
In both cases you enter into an agreement with the financing company, often a bank but not necessarily. Then as soon as you raise an invoice the finance company pays you an amount usual between 70% and 90% of the invoice Net value. So you have a large proportion of your income immediately and the rest of “Less costs and charges” when the invoice is paid by your customer.
If for any reason you do not get paid by your customer then that is your loss, as you will have to pay back any advances against the failed invoice. Some finance providers offer insurance cover that will protect you against non-payment; but not all.
Factoring – versus – Invoice Discounting
Back to what I mentioned to you earlier there are two slightly different takes on the same idea and some smaller variations from one provider to another. The main divisions are:
- Invoice Discounting – Works as we have said above and because you are a capable business who is adept at chasing it’s poor paying clients they leave you to do just that. You are responsible for credit control.
- Factoring – A factoring agreement will leave the finance company to do the chasing of any of your clients that are late in paying. This saves you a job, it avoids upsetting the customer as it is perceived to be external to yourself. Usually the factoring company, because they do it all the time, are better at it than you are likely to be.
“You pays your money and you takes your choice” by that I am saying that the factoring provider will generally charge you more than the Invoice Discounter.
What is it going to cost?
There are a few possible charges:
- Annual management fee in the case of Invoice discounting – 0.2% to 0.5% of annual invoiced amount. For Factoring the annual fee would be in the region of 0.75 to 2.5%. In both cases dependant upon your business size, record etc.
- For the period between you receiving a payment to the time that your customer settles their bill you will be charged interest. This will usually be a t a rate of 1.5% to 3.0% above the base rate and calculated on a daily basis.
All in all, without any major problems you should end up with 80% to 90% of your invoice face value.
Just one caution – beware of VAT. It is important to find out from the finance supplier of your choice if the amount paid to you and the charges paid by you are based on Net or Gross amounts ( before or after VAT). Unscrupulous finance companies can work these to their advantage and leave you to find it in the small print.
One last point to watch, returns, refunds and discounts. if you have to make any of these be aware of who pays and how. It will invariably be you but it can be in differing degrees.
To Factor or not to Factor
I have long understood the advantages of factoring but have never used it due to the type of business that I was in.
If you could tick one of the below as a major problem or more than one as significant , then Factoring could be the answer to your problems:
- Regular late payments of large invoices
- Large numbers of late-paying small invoices
- Late paying major client
- Company cashflow problems
If the above are not significant then I would strongly recommend that you find alternative ways to weather the storm.
A Major Consideration
Going back to my good friend the Bank Manager. He did not continue to try to sell me factoring purely because it was a good idea his bank obviously made a good profit on it. I soon realised that in my business I only had an occassional bad payer and then not for a large amount.
Although at the time these were annoying, and I would have loved to set the hounds on them, I had to consider that I would be paying the management fee on all my invoicing. So let’s say I invoiced £ 200,000 at 0.4% it would cost me £800.00 even with no late invoices at all.
I would recommend that, if you are looking to take up a factoring agreement, you take a good look at last years figures and see what it would have cost you and then balance that against what you would have gained on the cashflow side.
One Last – but Important Thought!
If you decide to take up a factoring facility and it is due to one client or a very small number of clients then I would recommend that you take it up for ONE YEAR ONLY. That this is clear to everyone involved and that the year is focussed on replacing the offender with a new business based on good payers. It will save you money, time and effort.
Even as you are reading this and I am writing it our wonderful politicians are debating ways to encourage ( we don’t like force) large businesses and Government bodies to pay their bills more promptly.
Will this change anything? I can only hope, but in the meantime following the above may just do the job.
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