A Guide to Factoring by Manus O'Donnell of Factor21
Cash flow is essential to the survival of all businesses. Unpaid invoices have value so factoring is a financial product designed to improve cash flow by providing finance against these unpaid invoices.
Any product or service on offer by a prospective client to its customers (on credit terms) can be deemed factorable if the product or service delivered is considered “contractually complete” with a robust audit trail (from customer order to proof of delivery) and verified by the customer.
Under this arrangement, the client business sells its invoices (book debts) to the factor when they are issued. The factor then pays the client up to 85% of the gross invoice value normally within 24 hours of receiving the copy invoices. The remaining balance - minus charges – is paid to the client once the debt has been collected.
For the client it is essentially “business as usual”, the only variation to the credit management function is the customers making payment direct to the factor and occasional verification of the debt.
Charges
The finance charge is expressed as a % over base rate with daily interest charged on the funds in use (on a compound basis) and charged to the client account at month-end – just like an overdraft.
The service charge is expressed as a % of turnover and charged against the assignment of each invoice. For instance, if the level of advance is 85% and the service charge is 1.0% then the client receives 84% in real terms of the assignment debt. The charge is subject to a “minimum” monthly charge which means that a business with a turnover of less than, say, £200k per annum will find the overall cost associated with factoring disproportional to the level of funding provided.
Frequently Asked Questions
Is a bank overdraft cheaper?
On paper, yes. However, factoring can provide more working capital than a bank even with the same security. Also, with the right provider, this also results in a closer and more responsive relationship
Personal guarantees?
Pgs are a prerequisite as the directors/shareholders are required to warrant that the invoices purchased by the factor are genuine and collectable. In a business failure scenario, a pg will encourage directors to assist in the collection of outstanding book debts.
Do I have to sign up for a minimum period?
12 months is the norm with a notice period of three or six months thereafter.
Funding restrictions?
The level of funding is geared to the invoices raised against the customer base. However, the product is formula-driven and if a key customer represents a large proportion of the debt there may be a concentration limit imposed by the factor. Also, the credit rating of key customers is crucial for setting specific customers’ funding limits. This can be mitigated by “selective” credit protection for specific accounts. Otherwise, the factor will provide a blanket funding limit for all other customers depending on the characteristics of the sales ledger.
This guide to factoring was written by Manus O'Donnell of Factor21.
