Three Powerful Tools To Improve Business Cash Flow

If your business sells to other businesses on credit then using an invoice, or debt factor to handle your invoices could give a much needed boost to your cashflow.

In essence you are selling your invoices to a third party, the factor, who in return for a discount on the value of the invoice will provide the cash before the invoice is due for payment by the customer, with the balance being payable to you on settlement by your customer, less all the factors charges.

Most factors will handle the processing of all the sales invoices, the management of the sales ledger, and debt collection, thus not only provide finance but also an administrative function.

Factoring could be described as a floating overdraft, providing availability of funds based on the volume of business you are doing, and an outsourced sales ledger process combined.

Factors will provide an agreed percentage of the value of each invoice, usually up to 85%. When an invoice is raised, it will contain payment instructions giving the factor's details, a copy of the invoice will also be provided to the factor themselves.

The agreed percentage of the invoice will be provided by the factor, usually within 24 hours of issue, and approval of the invoice.

The factor will then handle collection of the payment from your customer, operating credit control procedures, issuing statements, and dependant on the type of agreement you have, dealing with any bad debtors.

When the factor receives payment in full from your customer, the remaining funds will be forwarded on to you, with a pre agreed fee being paid back to the factor. Factoring agreements will normally contain an element of discount charges, these are in effect the interest charges on the overdraft, and are based on a percentage over base rate, charged on a daily basis on any advances used.

A recourse agreement will allow the factor to reclaim any unpaid invoices from you, and the agreement will make provision for this, stating an agreed time period after payment was due from the client for recourse to come into effect.

Non-recourse agreements will usually be more expensive and place increased restrictions on a business in terms of systems, processes and customers, but in return the factor will take responsibility for any bad debts, leaving your business less exposed to these liabilities. However a non-recourse agreement will not cover cases where a valid dispute over an invoice exists, and will mean you relinquish all rights to deal with bad debtors, including the right to take legal action.

Factoring's positive impact on cash flow is obvious, and cash flow being the downfall of many good businesses means that factoring an effective business debt help tool. However there are additional potential advantages and disadvantages that cannot be ignored.

Factoring reduces the administration of your sales ledger, as well as provide for improved financial planning. A good factor will also allow your business to have access to better customer vetting, and financial monitoring.

Having a third party handle the collection of payments from debtors can be a big plus, some businesses, especially smaller ones, may prefer to deal with you direct, however most debtors will treat a good factor with more respect than they may afford you direct when it comes to paying on time. It is important to recognise though that the way in which a factor deals with your customers is likely to have a big influence on their overall opinion of your business, good, or bad.

A good factor can also be a powerful strategic ally, opening doors to new opportunities and potential clients, as well as providing credibility with third parties such as banks, and financiers.

If your business has fundamental inefficiencies in its sales process then engaging a factor will probably not cure these. In fact a large amount of disputes or queries on your sales ledger could cause your factor to loose confidence in the business.

Factors may also want to impose restrictions on the types of businesses you deal with, either by dictating specific criteria for clients and/or a certain percentage of business from different profiles of client, or by imposing punitive charges on certain businesses that may be higher risk.

Many factors specialise in handling specific types of business, for example startups, or exporters, however businesses that benefit most from factoring will tend to fit some or all of the following criteria:

Your business is not reliant on a single customer for 25-30% of its turnover

Your business is spread across a number of clients, but does not involve the processing of large volumes of low value invoices

Your sales ledger is not subject to a large proportion of disputes from debtors.

The product or services provided use standard contracts, without the need for complex negotiations or arrangements on a customer by customer basis, and do not involve the business giving extensive warranty provision to its customers.

For larger businesses, with extensive systems and a proven track record invoice discounting may be available, invoice discounting will generally work on a much larger scale and involves the part financing of the total value of invoices issued in bulk.

Under invoice discounting the business retains full control over its sales ledger but provides the discount finance provider with aggregated data of its customers, invoices issued and payments received, and is in effect an overdraft secured on the total value of invoices issued.

Startups and small businesses can do a form of invoice discounting in house by offering debtors a discount on the value of an invoice if they pay within a prescribed period. For example on an invoice with 30 days terms, a discount may be offered if the customer pays within 7 days of the date of issue.

This form of DIY invoice discounting can also have an impact on value added tax liabilities, for instance in the UK the amount of VAT is calculated based on the discounted amount regardless of whether the customer take the discount or not. For example for a £10,000 invoice that offered a 10% discount for payment within 7 days the VAT would only be payable on £9,000 regardless of whether the customer chose to pay early or not.

Supplier financing is another form of alternative financing for businesses, sometimes referred to as reverse factoring or supply chain finance. Often used in manufacturing supply chain finance involves a business (usually a large business) providing its suppliers with low cost finance as part of a flexible settlement system.

The factoring market is serviced by a wide range of providers, some are subsidiaries of the big banks, some are specialists in specific areas. A business debt help factoring broker may be able to advise you on which type of factor may be best for your business, but remember all the points above when making a decision. Factoring is best seen as a long term commitment and will probably involve considerable effort to implement if it is going to be effective, and as such it is advisable not to make decisions based on cost alone, and as with any such process get good legal advice.


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