Debt Factoring and Invoice Discounting
Financial services companies that provide businesses with debtor finance, secured against unpaid invoices are known as Factors and Invoice Discounters.
Factors buy your trade debts and typically will pay 80% to 85% as soon as they receive a valid copy invoice. The balance, less charges, is paid when the customer pays. The Factor collects the debt from your customer directly but will usually agree collection policies with you, in order to ensure faster customer payment without loss of goodwill.
Some Factors also provide bad debt insurance.
With invoice discounting responsibility for collection of debts remains with you and the service is normally undisclosed to customers. Payments that you receive are paid into a bank account administered by the Invoice Discounter and you are then credited with the balance less charges.
Generally, invoice discounting is only available to businesses that already practice sound credit management and have the staff and accounting systems to generate reliable customer collections. Invoice Discounters, like Factors, will typically pay 80% to 85% against valid invoices.
Cost of Factoring and Invoice Discounting
For both factoring and invoice discounting there is a service charge, normally a proportion of turnover, and a discount charge, based on the amount of finance provided. Charges will be agreed in advance and form part of the factoring or invoice discounting agreement. For factoring the service charge is normally between 0.75% and 2.5% of turnover, depending on the workload to be undertaken. The charge for invoice discounting will usually be less, as less work is required. The discount charge is calculated on day-to-day usage of funds. It is likely to be comparable with normal secured bank overdraft rates.
Suitability of Factoring and Invoice Discounting
Debtor finance is most suitable for growing businesses; finance will grow in line with the growth in turnover. Conversely, where turnover is falling the level of finance will fall. The cost of the service needs to be weighed against the costs of in-house debt collection and, for example, having sufficient cash to benefit from early payment discounts from suppliers.
Generally debt finance providers are looking for ‘clean’ invoices where there is clear evidence of delivery of the goods or service and a low level of disputes or credit notes. It may not be available for some industries, for example contracting, where there is a high level of retentions and variation orders. Providers of debt finance usually acquire your debts with recourse to you if the debtor does not pay. This means they will reclaim the amount already advanced to you should your debtor not pay in a given time period. Alternatively, you may take out insurance against non-payment by your debtors. Many factors and invoice discounters can also provide bad debt insurance.
Finding a Factor or Invoice Discounter
More information and a list of providers of these services are available from the Factors & Discounters Association.
Questions to ask when selecting a Factor
- What will the service cost?
- How long will the agreement take to set up?
- How quickly will money be available against invoices?
- How quickly will you collect from customers?
- Who will be my day-to-day contact?
- Who will speak to my customers?
- How much notice must I give to terminate the agreement?
- Can you give me two or three references with similar businesses to mine?
- Can I factor export invoices?
- Are debts bought with or without recourse to me?
- Do I have to take out insurance against bad debts and, if so, can I choose who to buy the insurance from?
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