Why use them?

What to do when you need to use factoring or invoice discounting Why use factoring or invoice discounting? Debtor based finance has a number of advantages over traditional overdraft funding arrangements:

Debtor based finance Overdrafts
Flexibility Funding automatically expands directly with your debtor book to match the level of your trading Facilities tend to be set for periods of up to a year and therefore are slower to respond to an increased requirement for funds to match increased levels of trading
Level of borrowing possible Can provide a facility of typically 75% to 85% advance against current debtors Banks will typically provide overdraft facility to the value of 50% of your current debtors
Ability to borrow against finished goods stock Some invoice discounting facilities will allow an additional level of advance against finished goods stock Usually none
Credit control services Yes with factoring None
Bad debt protection Can be built in using ‘non-recourse’ arrangements None

Many of these factors make debtor based funding highly suitable for high growth companies where the access to flexible funding that can grow with the business helps eliminate the risk of overtrading.

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    Going further, if the key criteria for your business is maximising the level of funding that will be available, then by combining this type of debtor based funding with other ‘non bank’ sources of finance such as specialist commercial mortgages and plant and machinery based funding can allow you to raise significantly more than may be available through traditional high street banking arrangements. As shown in the How Much Can You Borrow Ready Reckoner below.

    Asset values Bank Mix of specialist lenders
    Property £Estimated open market value £60% £75%
    Plant and machinery £Estimated second hand value £Usually nil although may advance if significant £75% to 100%, less any existing HP or leasing liabilities which will have to be settled
    Debtors £Debts under 3 months old £50% £75%
    Finished goods stock £ £Nil £Can be used to ‘top up’ advance against debtors to say 100%
    Total £ £

    Debtor based finance does however have a number of perceived disadvantages such as:

    Stability of funding. As businesses see that when sales and therefore by implication levels of debtors fall, the funding available through debtor based finance will reduce as well, whereas an overdraft will not be affected in the short term giving you something to rely on.

    There are two problems with this analysis which mean that this is not normally as much of an issue as you might expect.

    Firstly, whilst it is true that levels of funding will track debtors down as well as up, you will also appreciate from what has already been said about the funding gap that your business’s requirement for working capital will also tend to reduce as your purchases will also reduce.

    Secondly, while an overdraft will not be affected by a very short term reduction in sales, the key here is the phrase short term. Since banks will normally base the level of overdraft they are prepared to provide on say 50% of your debtor book, you may therefore find that your facility suffers a step reduction once the bank has noticed your lower levels of sales and hence debtors.

    Reputation/stigma. Factoring has traditionally had a reputation as ‘funding of last resort’ and businesses have been concerned that their customers may see it as a sign of business distress.

    However this problem is much reduced as more and more businesses are being moved onto debtor based finance by their banks, while the higher funding levels achievable mean that it is now used as a matter of course in MBOs and MBIs to maximise the cash available to the business.

    And of course with confidential invoice discounting this issue is avoided altogether as none of your customers will be made aware of your financing arrangements.

    Costs. Factoring is often seen as an expensive form of finance, but as noted above, you have to ensure that you are comparing cost on a like for like basis and including all the costs involved in arranging, for example, bank overdraft finance.

    Exiting. Once you have this type of facility in place, it can be extremely difficult to get to a position where you can exit the arrangement.

    Next article: How To Choose A Factor Or Invoice Discounter

      Information provided is copyright and subject to the Important Notice on the home page.

      Of course the information contained in an article like this can never be a full statement of the legal position as the relevant laws are complex and liable to change. This article can only therefore be a general guide as to the issues involved and as these can have serious implications you should always seek appropriate professional advice on your own particular circumstances before taking any action.

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