Small Business Finance: Invoice Factoring

At National Pallets, most of our customers are small companies working hard to make a go of it. They choose us because we understand that timely, affordable pallet delivery of their product is the most important aspect of their business. No business, though, however efficiently run, is immune to late payments. They are a real problem in the UK and can badly squeeze a business’s cash flow. We recently covered a type of financing called invoice discounting. Here we discuss invoice factoring, which is an option available for the B2B market, not companies that sell to the public.

What it is

Unlike invoice discounting, factoring is not necessarily easy money, and microbusinesses aren't usually eligible. In this process, you will turn over all of your outstanding invoices to a financier. After an evaluation of your ledger, if you're accepted for factoring, the company will immediately pay you a percentage of all the invoices owed, pursue the outstanding balances for you, and pay you the remaining percentage when they receive the payments.

With invoice factoring, you will get all the monies owed you – unlike with discounting, in which you get only a percentage – but you will pay interest and fees.

Calculating whether it's right for you

Because the company will pursue payments on your behalf, you will be free to focus on actually running your business. Invoice discounting has you still doing the chasing yourself. Some factoring companies will also protect you against bad debt, so if you are deemed a good client for them, you could be entering a very beneficial relationship, in which both your time and your working capital are freed up.

Those fees and interest payments can really add up, though, and ultimately put a dent in your profits. Read the fine print on what you'll owe and what the repercussions are if any of your debts turn out to be bad.

A point in factoring's favour is that the service will also be responsible for checking the credit of your prospective customers, so you'll be less likely to incur lagging payments in the future.

With invoice discounting, your clients or customers don't know that you are using a service to get a cash "advance" against their debt, so they are still dealing with you directly. This is not the case with factoring, and depending on the tactics and attitudes of the company you use, it could affect your relationships. (Of course, if everyone paid their invoices in a timely fashion, you wouldn't have to turn to factoring, but that's another matter.) The issue here is that you can't choose which debts you turn over – a factoring provider takes everything on the books.

Another potential drawback is that turning to a factoring company affects your business's own creditworthiness. If you anticipate needing financing for growth or property or capital improvements – as opposed to quick cash infusions – you might damage your longer-term plans with invoice factoring, so it probably shouldn't be the first solution you turn to.

The HMRC will be implementing changes to the Prompt Payment Code and requiring large companies to publish their performance in paying invoices, but it is good to know that there are options a small business can look to when cash flow gets overly tight.