Factoring and invoice discounting
How factoring works
Factoring provides a fast prepayment against your sales ledger. It allows you to flexibly increase your working capital and improve cashflow by selling your unpaid invoices to a factoring company.
Factoring is offered to businesses trading with other businesses on credit terms.
When factoring starts
Factors can be independent, or subsidiaries of major banks and financial institutions. They will want to meet you, visit your business, review your financial situation and study your business plan.
After signing an agreement, the factor will agree to an immediate advance of up to 85 per cent of approved invoices - with the balance to be paid when the debtor pays the debt.
Factoring is more complex than other forms of funding, so you may wish to take professional advice before using factoring for the first time.
When an invoice is raised
- You raise an invoice, which has instructions to pay the factor directly and send it to the customer. Send a copy of the invoice to the factor.
- The factor makes available an agreed percentage of the invoice for you to draw as you require.
- The factor issues statements to the customer on your behalf. You will agree the protocol for contacting the customer with the factor beforehand.
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.
When an invoice is not paid
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. In recourse factoring you are liable for the debt, in non-recourse factoring the factor takes on any bad debts.
There are two main elements to the cost of a factoring arrangement. An agreed factoring fee is taken when the invoice is received by the factor. There will also be a 'discount charge' which is calculated against the balance of funds drawn and usually applied on a monthly basis.
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