May
04
2009

What is debt factoring and invoice discounting?

Without cash flow, your business will end up like these cogs: unworkable (photo by ralphbijker CC-BY)

Without cash flow, your business will end up like these cogs: unworkable (photo by ralphbijker CC-BY)

If your company sells goods or services to other companies, you will normally offer credits terms once you are satisfied with the their credit worthiness. Occasionally a purchaser will default on their payment by delaying payment of the debt, or even worse, going into liquidation. This often causes havoc with your cash flow, squeezes your working capital, and can even put your own business in jeopardy. Two solutions are debt factoring or invoice discounting.

Debt Factoring or Full Service Factoring is a service provided by banks and finance companies. When your company raise an invoice for goods or services your company has supplied, the factoring company will immediately pay you a percentage of that invoice value. This can vary between 85% and 95%. When the full value of the invoice is paid to the factoring company, then you will receive the remaining value, less their fee.

In effect you are selling the debt to the factoring company for a fee plus interest. The benefit is that you immediately receive your money and the factoring company deal with collecting the payment. However, if ultimately the debt is not paid, then the bad debt will revert to you; unless for an additional fee, the factoring company takesover the bad debt. Charges for factoring vary, but fees of 0.75% and 2.5% of turnover is often quoted, which shows that it is best to shop around for the best deal for your business.

Invoice Discounting is similar in that your company receive immediate payment, often up to 95%, but it retains management of the sales ledger and your customers are unaware of the existence of the factoring company. It is not suited to all types of businesses and requires a high level of turnover. Fees vary between 0.2% and 0.5% of turnover.

For more information on how debt factoring and invoice discounting works, visit the UK’s Business Link website.

Another alternative when hit by bad debts is trade credit insurance.

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1 Comment »

  • Factoring guy says:

    The author has forgotten to mention that there are far more fees related to factoring. In many cases, when deciding to use factoring, we can be obliged to accept another charges like:
    – credit management fee
    – setup fee
    – periodic fee
    – wire transfer fees
    – due dilligence fees
    – others…
    Of course it depends on the financial institution which fees to charge, but generally the cost of factoring is a bit higher than the cost of a traditional loan.

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