Invoice Finance: Factoring and Discounting

If your business needs to improve cash flow, options like invoice finance, factoring and discounting can offer an immediate cash injection.

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✓ Learn about business funding options beyond bank loans and overdrafts

✓ Understand the pros and cons of available solutions before making decisions

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✓ Discuss your financial circumstances in confidence to help relieve your stress

  • COULD BUSINESS FINANCE, INVOICE FACTORING OR INVESTMENT HELP MY CASH FLOW?

Poor cash flow is often the first sign of a business experiencing financial difficulties, and it can have serious consequences if it is not resolved quickly. It can be caused by a variety of factors, including the loss of an important customer, poor credit control or late customer payments. These problems can spiral quickly but, in many cases, a short-term cash injection can be enough to restore a company to a viable financial position and lead it on the path to recovery.

Organisations in this position often turn to invoice finance, factoring and discounting as methods of providing cash and breathing room. These approaches can help to resolve short-term cash flow problems and give you the space you need to implement long-term company rescue procedures. In turn, implementing new credit control procedures, changing your credit terms or developing more capacity to chase late payments can help to prevent these challenges from arising in the future.

With invoice factoring, a company sells its unpaid invoices to a finance provider for a percentage of their value. The invoice finance provider chases payment from the original company’s customers, and delivers the remaining balance once payment has been collected, minus their fee. If customer non-payment is the cause of your cash flow challenges, using a factoring service can be a fast way to generate a cash advance

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  • WHAT ARE INVOICE FACTORING AND INVOICE DISCOUNTING?

If you are certain that additional financing will be the most viable way to resolve your cash flow challenges, there are several methods you might consider to raise extra funds. Two of the most common are types of invoice finance: factoring and discounting. These approaches are particularly suitable if your business is struggling to bring in cash because you have offered lengthy invoice payment terms to customers.

Invoice Factoring

Invoice factoring or discounting may offer a quick, short-term solution and help you to avoid the more serious consequences that arise when a company cannot afford to pay its debts.

Invoice factoring means selling your invoices to a third-party factoring company, usually for 60-80% of the value of the invoice. The factoring company will then collect payment from your customer per their usual terms and pay you the remainder of the invoice value, minus a collection fee. This allows you to offload credit control responsibilities to a third party, which can be especially useful for companies that do not have the resources to chase payments themselves. For a small business, factoring may be the key to restoring financial solvency.

At the same time, there are potential downsides, as we will discuss in more detail below. Your customers will become aware that you are working with invoice factoring providers when the factoring company chases the debt on your behalf. This can create difficulties for organisations and affect their reputations. If customers learn that you are experiencing cash flow challenges, they may also decide to take their business elsewhere, which can make it more difficult for a company to overcome its financial woes.

Invoice Discounting

Invoice discounting works in a similar way to invoice factoring, except that the business maintains responsibility for chasing and collecting the invoice payments. This means that invoice discounting is confidential, and there is no need for your customers to learn that you are financing invoices.

It is important to remember that your individual arrangement with your finance solution provider will determine how much money you can receive and, in some cases, discounting or factoring companies will purchase the invoices for a percentage of their value but you will not receive the remaining balance once the customer has paid. You should review the terms of any financing arrangement you are offered to ensure it meets your requirements.

Choosing the best course of action will require a thorough understanding of the causes of your financial difficulties, as each approach has different advantages and disadvantages that may make it especially viable for your business. It is important to research these options thoroughly, or speak to an expert before making a decision to avoid choosing an unsuitable solution.

  • HOW DOES INVOICE FACTORING WORK?

If you determine that invoice factoring is the right solution to provide your company with fast access to cash, the process through which this will unfold is common to many factoring companies and will usually be the same no matter which service provider you use. Here is a detailed breakdown of how invoice factoring works in practice:

  • Sale of invoices: A company sells some or all of its outstanding invoices to a factoring company. This sale is not merely a transfer of the right to collect but also involves the sale of the ownership of the invoice.
  • Advance rate: The factoring company then provides the business with an advance, which is a percentage of the total value of the invoices sold. This percentage typically ranges from 60% to 90%. The advance rate is determined based on several factors, including the creditworthiness of the business’s clients and the risk assessment of the factoring company. It is often wise to consult with several service providers, as most factoring companies will offer discrete terms and you can ensure you get the best deal by comparing them.
  • Creditworthiness check: Before agreeing to factor invoices, the factoring company will vet the creditworthiness of the client who owes the invoice. This is a crucial step as it affects the risk that the factoring company is taking on and the resources it may need to expend to collect payment​.
  • Collection of payments: The factoring company takes on the responsibility of collecting the invoice payments from the debtors. The factoring company essentially becomes the owner of the debt and handles repayment. This is similar to the role of a debt collector. For businesses that lack the resources to collect payment themselves, this is the primary advantage of invoice factoring services over other finance approaches.
  • Remaining balance settled: Once the client pays the invoice, the factoring company will remit the balance owed to the original owner of the invoice, after deducting the factoring fee and the amount of the advance already paid.

In essence, invoice factoring turns a business’s accounts receivable into immediate cash, allowing for more fluid management of operations and investments without waiting for clients to pay their invoices. This can also highlight to the company if generous payment terms for debtors are the cause of their cash flow challenges. However, it should not be confused with accounts receivable financing, which encompasses a number of other approaches.

  • WHAT IS THE INVOICE DISCOUNTING PROCESS?

Like invoice factoring, invoice discounting is a financial service that provides businesses with immediate capital by enabling them to borrow against their unpaid invoices. Here’s how the process typically unfolds:

  • Selling invoices: A business sells some or all of its unpaid invoices to a third-party finance company at a discounted rate. This allows the business to benefit from an immediate cash injection without needing to wait for its payment terms to end.
  • Receiving the advance: The finance company provides the business with a cash advance that is a percentage of the invoice’s value, which can be up to 95% of the invoice amount. This will depend on factors like the company’s credit rating and the results of credit checks on the debtors. This advance payment acts as a short-term loan based on the face value of the invoices.
  • Repayment: The business remains responsible for chasing and collecting payment. Once the business’s customer pays the invoice, the business then pays the finance company the amount that was advanced plus a factoring fee. The fee is for the service of advancing funds and taking on the risk associated with the invoice.

The primary purpose of invoice discounting is to give your company a necessary cash flow boost and allow you to continue operations without the constraint of waiting for customer payments. It acts like overdraft protection on the business’s accounts receivable and can be viewed as a short-term loan that is repaid when the customers settle their invoices. It is a flexible process, in that a business can choose which debtors and invoices to discount. This allows them to use the service as needed and manage their cash flow more precisely, which can offer benefits to companies that already have a strong understanding of the causes behind their financial challenges.

  • ARE THERE ADVANTAGES TO INVOICE DISCOUNTING VS. FACTORING?

Invoice discounting and invoice factoring both have advantages and disadvantages that companies must consider before choosing a solution. The following aspects could help businesses to identify whether one or the other approach is the most suitable:

  • Cost: Invoice discounting typically costs less, ranging from 0.75 – 2.5% of the invoice’s total value. Factoring often includes a service fee plus an additional administration fee, which can be between 1.5 – 5% of the invoice’s total.
  • Control over sales ledger: With invoice discounting, your business maintains control over its sales ledger and collections process, while with factoring, the provider takes over the collections and sales ledger administration. Companies using invoice factoring do not have to manage their receivables or chase after unpaid invoices as the factoring provider handles this, potentially saving time and administrative resources. Your company’s ability to collect payment and manage credit control processes will often be the main factor in determining whether invoice factoring or discounting is right for you.
  • Confidentiality: Customers are usually unaware of invoice discounting, which can help maintain normal customer relations and your business’s reputation. In contrast, factoring companies inform your clients that they are taking over the collections process, which is one of the key downsides of this approach. However, for some businesses, the ability to offload responsibility for credit control makes factoring the best option.
  • Risk and responsibility: Invoice discounting often places the onus on the business to manage payment collections and risks, whereas invoice factoring is typically non-recourse, meaning the factoring company assumes the risk if the customer fails to pay. This is not always the case and depends on the individual agreement you have in place with the factoring company. Because factoring is usually non-recourse, it is usually easier to get approval for and it won’t affect who you can work with based on creditworthiness.

There are advantages to both of these processes over other types of finance. Factoring and discounting can be more cost-effective than traditional business loans, and companies may find it easier to enter into the factoring process than securing a loan. At the same time, this relies on a business having a sufficient volume of unpaid invoices, whereas securing loans from financial institutions does not.

  • WHAT TO DO NEXT

Invoice financing is a good way to create some breathing room for a company that cannot afford to pay its debts, but it is not a long-term strategy and will not deliver an improved cash flow position over time. As such, invoice factoring finance should only be considered in addition to other strategies that are designed to address the challenges your business is facing at their source.

It can be difficult to know what is leading to cash flow problems, because the possible causes are varied and it may not be possible to draw a straight line from the cause to the effect. In these cases, it can benefit you to work with an expert who can advise you on better cash flow control and the long-term strategies you need.

The team at Company Insolvency Advice has a wealth of experience in helping businesses that are experiencing cash flow problems to understand and address the causes, with a combination of credit control strategies, debt management and invoice finance solutions. Each approach must be bespoke, because each business is different, and we work hard to understand your individual needs so that we can provide relevant company rescue solutions for you based on your financial circumstances.

If you believe that invoice factoring services or another type of invoice financing could enable you to access cash quickly and begin to recover your business from financial hardships, contact our team today. Our expert advisors can discuss the options that are available to you and help to forecast the outcomes, so you can make decisions with the full knowledge of what to expect.

Call us today on 0800 999 0666 or use our online enquiry form to request a call back at a convenient time for you.

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