Invoice Finance & Factoring
Invoice financing (otherwise known as debtor finance) is a way of making money available quickly as soon as a piece of business has been completed. Essentially, it involves outsourcing responsibility for invoices to an established lender. The lender (or "factor") loans your business a set percentage of an invoice's value upfront, and then proceeds to collect the full payments on your behalf.
There are a number of benefits to this approach to financing, but the most obvious is that it increases your cash flow by giving you access to funds almost immediately - within 24 hours, as opposed to the six weeks or longer that it could take if dealing with clients directly.
It makes sense that this release of working capital is particularly useful for companies who are growing, and although there seems to be a perception that factoring is only for established companies, there is actually a growing number of factoring companies who will consider lending their services to new businesses just setting out.
Factoring may therefore be a viable alternative to a bank overdraft, and will perhaps be easier to arrange. Factors will be less concerned than banks with evidence of a firm's financial track record, as all lending is linked directly to sales. Another benefit is that there is no ultimate limit to the amount that can be borrowed, as it will always be a percentage of the work completed.
In some cases, in fact, it may be possible to raise as much as 100 per cent of a transaction. Generally, however, the initial sum given by the factor will be worth around 80 per cent of the value of the invoice, with the remainder arriving when money is paid to the factor. The factor will usually take on the responsibility for ensuring all these payments are received, including contacting customers by phone if payments are missed and setting interest levels or credit policies.
For all of this, the factor will of course charge interest. Typical charges on the amount loaned upfront will probably be between 1.5 per cent and three per cent above the Bank's base rate (currently 4.5 per cent). There will also be a charge for the service of handling the sales account, and this will be linked to annual turnover, as well as the volume of invoices that are processed. The least that could be expected is 0.5 per cent, rising to 2.5 per cent depending on the circumstances.
It is also possible to arrange a "non-recourse" facility to ensure that you are not penalised if a client fails to pay a debt. Instead, the factor will pay with its own insurance. Without such an arrangement, you may be required to pay the factor for the value of such outstanding debts. The cost of the "credit insurance" charged by the factor will usually be somewhere between one and two per cent of turnover in this case.
Factoring may not be suitable for all businesses, particularly if they rely heavily on a personal relationship with clients. The factor will be able to impose its own credit limits on the business's customers, and will have its own approach to the collection of outstanding debts, which companies may not appreciate.
If reluctant to relinquish their relationship with customers, a business may therefore prefer invoice discounting rather than factoring. Here, the lender's role will only be a financial one, and the company will still have to collect its own debts and then repay the factor.
Nevertheless, factors will usually be open to agreeing an approach with individual customers, and can therefore save a business a lot of the time and stress of collecting payments. A factor can also help with conducting business overseas and in different languages, and a business may also benefit from observing its factor's expertise in the area of credit management.
Any business, whatever its size or nature, will need a bank account in order to carry out its work, and securing the best deal for the business's specific circumstances is therefore one of the most important considerations for any company starting out.
In terms of which bank to choose, it naturally makes sense to look at what is offered by the bank where a personal account is held. However, it is important to compare this with several other deals offered by different banks. Different facilities may be offered, such as internet and telephone banking, and bank charges will vary.
Although a bank will publish its standard tariffs for businesses, it is always worth negotiating to try and get a better deal.
Here again, it is important not to automatically settle for the same bank that is used for a personal account. Banks that are looking to attract a new customer may well make a better offer.
Banks can either choose to charge for each piece of business that passes through an account, or may charge a fixed amount per period, for example by month or quarter. Alternatively, charges may be based on the amount of money passing through an account over a given period, i.e. the turnover. For example, HSBC offers a different charging mechanism depending on whether the business's turnover is greater than or less than £500,000. It imposes a standard "small business tariff" for the latter and a negotiated "money transmission" pricing system for turnovers higher than £500,000.
In general, however, it is worth remembering that banks charge more for accounts where more cheques are transferred. Automated payments, such as over the internet, are generally cheaper, as well as often being more convenient. Internet banking also allows you to view direct debit payments and offers telephone support in case of problems, although hours can vary.
It is also possible for a business to borrow from the bank, although it will need to provide documents constituting evidence of an ability to repay. Fixed term loans may be a better option than overdrafts in the long run, as banks can demand overdrafts are repaid at short notice. Banks can also provide guidance about other sources of funding, such as grants.
Of course, banks lend based on the ability to repay, so a business plan will need to show that this prospect is viable. It will want to know whether the business is making a profit and will make a judgement as to whether future predictions are likely to materialise.
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