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Factoring: How does it work?

POSTED: 10th June 2015
IN: Guides
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According to the research conducted by Bacs, more than a quarter of companies have to use their overdrafts to make ends meet and one in ten struggles to pay staff and suppliers on time.

undefinedWith 76 per cent of UK businesses having to wait at least a month before getting paid, the burden of late payments on SMEs reached £32.4bn in 2015. 

When faced with late payments, it’s not unusual for businesses to turn to credit cards, loans and overdrafts to help their cash flow issues. However, as a business owner it’s important to realise that there are many other business finance solutions available to help to improve cash flow. Invoice factoring is just one financial option that could help to regulate working capital.

Unlock the cash you need

If a company is faced with late payments, factoring will release the cash ‘locked’ within those unpaid invoices.

Factoring could also save business owners valuable time as well as money, particularly if the company is constantly chasing customers for payments. A factoring provider will manage the debt collection and work with the business’ customers on its behalf.

How does invoice factoring work?

The factoring process will involve the following steps:

  1.        The customer places an order with the business
  2.        The business completes the order for the customer and raises the invoice
  3.        The business sends the invoice to the factoring provider
  4.        The factoring provider releases an agreed percentage of the invoice value to the business
  5.        The factoring provider will contact the customer for payment
  6.        The customer will pay the factoring provider

The provider will advance a percentage of the invoices’ value, giving the business fast access to the cash it needs. In some cases, a new invoice could be advanced by the next working day. The below graphic demonstrates how the factoring process works between the customer, the business and the provider.

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What are the benefits of invoice factoring?

As a source of finance, invoice factoring offers businesses an alternative to the traditional bank loan, credit card or overdraft facility. Factoring enables a business to strengthen its cash flow by utilising the cash owed to the business. Factoring could offer companies the following benefits:

Access to more funds

Depending on the financier, businesses may be able to secure more funding with invoice factoring than they would from a loan. Unlike a loan, a factoring facility will not be subject to being ‘called in’ at any time by the provider. A further advantage of a factoring facility is that the funds available to the business expand as the company grows too.  

Help to cope with seasonal demands

When faced with seasonal rushes or surges in demand, invoice factoring can help businesses by ensuring they have cash available to accommodate the changes in trading levels. Businesses will be able to gain prompt access to a percentage of their invoices’ value, meaning that cash flow doesn’t become a barrier to fulfilling orders.

Increased profits

Factoring can also help companies to seize opportunities as soon as they arise. Knowing the finances are available could give businesses the confidence to accept new business and grow their client base.

Invoice factoring can prove to be a proactive finance solution for budding SMEs who need the financial support to manage their cash flow closely and grow their businesses.  Factoring is now part of the mainstream mix of business funding sources, and in 2014 nearly £23 billion of finance was provided to UK companies, a rise of seven per cent compared to 2013.

If you think that invoice factoring could be the answer to your cash flow concerns, please get in touch with Aldermore for more information. 

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