This is used basically to reduce administration overheads & thereby improve the Cash flow. Businesses that supply this service are called factors or debt factoring companies.
Invoice discounting is an alternative way of drawing money against your invoices. However, your business retains control over the administration of your sales ledger. It offers valuable support services and credit insurance.
This guide gives information on how debt factoring and invoice discounting work,the advantages and disadvantages, different types of factoring and invoice discounting, the cost, and how to choose a factor or discounter.
How debt factoring works
Factoring provides a fast prepayment against your sales ledger, at a cost, to flexibly increase your working capital and improve cash flow.
Factoring is offered to businesses trading with other businesses on credit terms. It is not normally available to retailers or to cash traders.
When factoring starts
Factors can be independent or subsidiaries of major banks and financial institutions. business, review your financial situation and study your business plan to evaluate your suitability for a factoring facility.
After signing the agreement, the factor will typically agree to advance up to 85 per cent of approved invoices. all sales go through the factor.
Check the notification period - most factors require three months' notice to end Negotiate if you are not happy with the notice period.
Factoring is a complex, long-term agreement. solicitor on the legal and financial implications of factoring.
When an invoice is raised
- You raise an invoice, which has instructions to pay the factor directly and sendit to the customer. Send a copy of it to the factor.
- The factor pays an agreed percentage of the invoice to you.
- The factor issues statements to the customer on your behalf. It operatescredit control procedures including telephoning the customer if necessary.When an invoice is paid by the customer
- The customer should pay 100 per cent of the invoice directly to the factor.
- The factor pays the balance of the invoice to you. Fees and interest will be deducted from the payment. factoring and invoice discounting.
If an invoice is not paid, responsibility for paying the debt will depend on the type of agreement - either recourse factoring or non-recourse factoring. page in this guide on recourse factoring and non-recourse factoring.
Advantages and disadvantages of factoring
There are numerous advantages to debt factoring, but also some potential
drawbacks.
Advantages
Factoring provides a large and quick boost to cash flow valuable for businesses that are short of working capital.
Other advantages:
- there are many factoring companies, so prices are usually competitive
- it can be a cost-effective way of outsourcing your sales ledger while freeing upyour time to manage the business
- it assists smoother cash flow and financial planning
- some customers may respect factors and pay more quickly
- you may be given useful information about the credit standing of your
- factors can prove an excellent strategic as well as financial resource whenplanning business growth
- you will be protected from bad debts if you choose non-recourse factoring
- cash is released as soon as orders are invoiced and is available for capital
works best when a business is efficient and there are few disputes and queries.
Other disadvantages:
- The cost will mean a reduction in your profit margin on each order or service fulfillment.
- It may reduce the scope for borrowing - book debts will not be available as security.
- Factors may want to vet your customers and influence the way that you do business.
- Some customers may prefer to deal directly with you.
- How the factor deals with your customers will affect what your customers think of your reputation.
- You have to pay extra to remove your liability for bad debtors.
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