Due to the credit crunch and many banks' unwillingness to lend, businesses are finding it difficult to raise money to finance their activities. Factoring and Invoice Discounting can allow a company to improve its cash flow.
In the current economic downturn with many banks' unwillingness to lend, businesses are finding it difficult to raise money to finance their activities using traditional sources such as an overdraft, credit card or loan facilities. Faced with this situation, a large number of companies companies are turning to sources of income such as factoring and invoice discounting.
Factoring and invoice discounting allow a company to improve its cash flow by borrowing against legitimate invoices that have been raised. Using this facility the company is usually able to access 80% of the invoice value immediately without having to wait for the normal payment period. There are three main ways to do this:
- Invoice Factoring
The process of invoice factoring involves a Factoring Company (often a bank) taking over a company's invoicing and credit control function. When invoices are raised, the factoring company immediately makes credit available to the company. The name of the factoring company is stated on the invoice and the payment of the invoice is made directly to the factoring company. Payment collection and credit control are often managed by the factoring company.
- CHOCCs Factoring
CHOCCs stands for Client Handles Own Credit Control. This type of factoring is similar to full factoring except that the client maintains responsibility for collecting payment of the invoices. It has the advantages that it will normally be a cheaper service and more control is maintained over the payment relationship with the company's clients.
- Invoice Discounting
Invoice discounting is similar to factoring in the sense that a factoring company will make credit available to the business as soon as an invoice is issued. However, the service is discreet. The company sends out invoices and collects payment in the normal way, but the factoring company's name does not appear anywhere and debtors will therefore be unaware of their involvement.
The different factoring facilities would be used depending on the nature of the business. For example, where it is important to ensure that the involvement of a factor is not disclosed, invoice discounting may be a more appropriate method. Where this does not matter or in fact where it is seen as an advantage to involve a third party to help in the collection of debts, then full factoring may be the correct solution.
It should be noted that Invoice Discounting is seen as a bigger risk by the factoring company as it must have the confidence that the business it is lending to will tightly manage its debt collection processes. Because of this smaller amounts than the 80% of invoice value are likely to be made available up front by the factoring company.
It is important to understand that invoice factoring provides access to money based on business activity which is already happening. For factoring or discounting to work, the business must be already generating or imminently generating invoices. As such, it is an ideal way to improve the cash flow of the business which is currently operating. Having said that, however, invoice factoring or discounting can also be an ideal solution to help improve the cash flow position of a new business such as a Phoenix company. Here invoices will start to be raised almost immediately and so a factoring facility could be used.
Because Invoice factoring or discounting focus on cash flow improvement, they are not usually a good way of raising a lump sum for a specific business project. If this is your requirement and a bank loan is not available, then a more suitable option may be asset refinance.
Invoice financing and discounting are not without cost. Normally both options involve a service charge (which may be between 0.5% and 1% of the sum lent) and a rate of interest. However, where a business is looking to improve cash flow and more tradition methods of achieving this such as bank overdrafts and credit cards are being withdrawn, invoice financing and discounting is often an extremely useful solution.
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Derek Cooper is Managing Director of
Cooper Matthews Limited.
If your business is need of some additional cash flow, but traditional loan sources have been denied you then look at
http://coopermatthews.com/business-refinancing.html.
Derek's experience of both corporate insolvency and business management puts him in a position to be able to understand the challenges facing businesses in today's economic climate.
