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What is Debt Factoring?
Debt Factoring is another term for invoice factoring (also known as invoice finance), wherein a business passes on unpaid invoices for work completed or products sold to a debt factoring company. That factoring company will subsequently pay your business upfront for the invoices and assume responsibility for collecting the debt.
In most cases, you'll receive as much as 90% of the value of the invoice, with the remaining balance (less the factoring fee) paid when the outstanding invoice is paid to the factoring company.
How does debt factoring work?
Essentially, debt factoring allows your business to release funds from unpaid invoices, making a notable difference to your cash flow.
For example, if a business that makes sales of £10,000 per month has payment terms of 60 days, they could be owed £20,000 in receivables at any one time. This business could sell the majority of unpaid invoices (e.g. 90%) to a factoring company, giving them almost immediate access to £18,000 through debt factoring.
The debt factoring company will subsequently attempt to collect the invoice payment from the customers, sending the remaining value of the invoice to the business, less a fee. In this example, if the factoring company charged 3%, the business would receive a further £1,400 meaning that they only paid £600 to the factoring provider.
Put simply, debt factoring can be exceptionally beneficial for businesses struggling with cash flow or liquidity. Through a relatively small fee, your business gains access to funds already owed to them. As an added benefit, your business doesn't have to spend time chasing unpaid invoices.
How Does Debt Factoring Improve Cash Flow?
A major benefit of debt factoring is that it can help to improve your business's cash flow. Instead of waiting for your customers to pay, you can get your hands on capital as soon as the invoice is raised. By using debt factoring, you can pay your employees, suppliers and other parties earlier, giving your business financial space to grow.
What are the Advantages and Disadvantages of Debt Factoring?
Debt factoring can be viewed as a viable way of improving your financial outlook. By using debt factoring against outstanding invoices, you’ll receive money from the debt factoring company immediately, so you won’t have to wait for your customers to pay. However, there are some disadvantages to debt factoring, which we've summarised below alongside the advantages.
Debt Factoring Advantages
Your business gets quick access to cash when you need it. Typically, money will arrive in your business account between 24 and 48 hours after submitting your invoices.
You can improve your business cash flow, as you no longer need to wait for your customers to pay. This allows you to put funds back into the business almost immediately.
You can protect your business against bad debts if you opt for non-recourse factoring. This means that if your customer becomes insolvent during the factoring period, your business doesn’t have to shoulder the cost.
Your business can benefit from a simpler collections process. Because the debt factoring company takes responsibility for collecting invoices as they fall due, you can focus on growing your business.
You can protect your business against debts from unpaid invoices. Because debt factoring gives you access to owed funds, you don't have to wait for payment from slow-paying customers.
Debt Factoring Disadvantages
Your business could pay a higher interest rate compared to financing sourced from a bank or building society.
Your business may risk straining your customer relationships. This is a more likely risk in cases where your customer relationship is already strained. However, you can avoid further straining your customer relationship by choosing a reputable debt factoring company.
Your business could be liable for bad debt. Although some debt factoring companies provide debt protection, they may pass responsibility for unpaid sums back to your business.
Your business could pay higher fees if you have slow-paying customers. This is because the factoring company has to spend more time and effort.
Your business won't receive the full invoice amount. Because the debt factoring company takes a relatively small fee for their services, your business won't receive the full amount of the unpaid invoice.
What Are The Criteria for Debt Factoring?
To be eligible for debt factoring and other forms of invoice financing, your business will need to meet the following criteria:
Your business must operate on a B2B basis, meaning your customers must be other businesses.
Your business usually needs to be a registered limited company or LLP (Limited Liability Partnership), but some lenders are willing to accept applications from other types of companies.
Your business must use credit terms that are standard for your industry.
Your business should have a minimum turnover of £50,000.
Your business may be required to issue a minimum number of invoices per month, depending on the factoring company you choose to work with.
If your company meets these criteria, you may be eligible for debt factoring. To find out more, simply click the link below to quickly and easily compare current offers.
Debt Factoring FAQs
Debt factoring is an external source of business finance. This is because the funds originate from a factoring company that is external to your business.
Debt factoring is generally considered a short-term source of business finance that helps with cash flow and increases working capital. In some circumstances, debt factoring can be a long-term solution, but this is usually only applicable to businesses with high-profit margins and a limited number of clients.
Yes, finance factoring is another term for debt factoring, also referred to as invoice factoring and invoice finance. It's the act of selling unpaid invoices to a factoring company to gain access to capital and pass on the responsibility of obtaining the funds in exchange for a relatively small fee. We've outlined how debt factoring works towards the start of this page.
Debt factoring can be an effective way to improve your company finance. It gives your company quick access to funds that you're already owed without needing to expend a lot of company resources. It's important to weigh up the pros and cons of debt factoring, but you may find it useful to compare debt factoring offers.
Factoring is a form of business finance, but it’s often not considered a form of debt or even a business loan. This is because neither the factoring company nor the business issue or acquires any debt during the transaction. The funds provided by the factoring company are paid in exchange for your business’s receivables (invoices). Subsequently, debt factoring is closer to a debt transaction than a debt arrangement.
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