The Pros and Cons of Invoice Factoring

Many businesses face cash flow problems due to unpaid customer invoices. Invoice factoring is becoming increasingly popular as a solution to this challenge. As specialist invoice factoring brokers, we want our clients to be as prepared as possible in their search for the right funding provider.

Let’s run through the advantages (and the potential drawbacks) of invoice factoring.

What Are the Pros of Invoice Factoring?

We’ve gathered some of the main business benefits of invoice factoring together under six key points.

1. Get cash immediately

Probably the most important advantage of factoring is the instant injection of working capital it provides to a business. This speed is a major advantage over more traditional business options like bank loans, which can take months to be approved (and even more time before the money is actually in your bank).

By comparison, the lenders we work with will be far quicker to assess the viability of a factoring facility for your business. Many of them can advance cash directly to you within 48 hours. This can quickly shore up your cash flow and keep your business wheels spinning.

For this reason, factoring can be especially valuable to businesses with a small customer base paying larger-value invoices, where late payment of a single invoice can be a very real danger to business continuity.

2. Get approved quicker and more easily

Invoice factoring providers look forwards, not back. Their concern lies in the payment history and creditworthiness of your customers, not your own credit score.

Likewise, invoice factoring uses your unpaid invoices as collateral, so you don’t have to worry about the potential loss of any costly or business-critical assets (as with asset-based lending).

Invoice finance is also a highly competitive industry. That means that funders will be hungry for your business and costs will be kept low compared to other forms of business finance.

3. Outsource your credit control admin

Factoring involves handing over control of your invoice payment collection to the funder. This eases the time-consuming admin burden of chasing late payments. Research by the challenger bank Tide in 2020 suggests that the UK’s SMEs alone spend 900,000 hours on this task (that’s an hour and a half every day).

By freeing up the time you would otherwise spend chasing unpaid invoices, you’ll be able to focus on what’s important: growing your business and keeping your customers happy.

Another benefit of outsourcing your credit management is that your customers may be more likely to bow down to a larger financial provider as a creditor than they are to you (especially if you’re a relatively small company). A call from a big name in global financial services is likely to command more respect, and that may mean your customers settle their debts more promptly.

Working with a factor also means you’re likely to get access to bad debt protection, which insures you against a customer failing or defaulting on their outstanding payment. Non-recourse factoring also gives businesses the option for the funder to be responsible for the debt if it turns bad.

It’s also worth bearing in mind that other invoice finance products are available if you don’t want to disclose your arrangement with a factor (confidential factoring), or if you also want to retain control over your invoice collection function (invoice discounting).

4. Know/serve your customers better

By handing over the ‘bad guy’ responsibilities of debt collection to a third party, you can focus on building stronger, more positive relationships with your customers and earning their repeat business over the longer term.
Equally, the credit checking services provided by your factor will safeguard you from entering into high-risk propositions – reducing risk is in your best interest as well as theirs.

5. Keep your cash flow stronger for longer

While some businesses use invoice factoring to resolve short-term cash flow problems, many of our clients enter into more lasting arrangements with their factoring provider.

As brokers, we also look after this relationship through regular check-ins to make sure you’re getting the most value.

Having a consistently positive cash flow can also have the added benefit of paying your own suppliers sooner, allowing you to negotiate and unlock discounts on your purchasing.

6. Improve your strategic decision-making

Better cash flow means better financial planning and fuel for growth. By knowing exactly when your advance payments will come in from your financier, you’ll be able to take the calculated risks necessary to expand your business. For a startup, for example, evidence of a positive cash flow could be a key point of difference that attracts new investors.

Unlike a bank loan or overdraft, when the funding amount is fixed, the funding available through invoice finance grows with your business. The more invoices you raise, the more funding can be released. By the same token, you are never obliged to release the full cash value available to you, which can be beneficial in quieter periods.

What Are the Cons of Invoice Factoring?

We’re all about transparency when it comes to invoice finance, so it’s worth acknowledging the potential pitfalls as well as the clear and obvious benefits. Here are the top 3 to bear in mind.

1. The cost of invoice factoring

Advancing money against your unpaid invoices comes at a cost payable to the lender. Some factoring companies charge between 1% and 5% of the total invoice value in service fees.

Choose to work with us, on the other hand, and you can expect your costs to be between 0.1% and 4%. As an example, we recently obtained a client all-in costs of 0.67% on a £1.2 million turnover.

Typically, you can expect to pay a fee for every invoice factored, plus variable interest on the money advanced. To counteract this, some lenders now offer bundled fees so there is no interest variable.

2. The loss of control

Understandably, some business owners might feel uncomfortable about handing over credit control to a third party.

That said, you don’t hand over complete control. Ultimately, these are still your customers and you dictate how you want the lender to act on your behalf. Working with the factoring provider means you can structure a more robust invoicing process, so that if (for whatever reason) your customer doesn’t pay, you’ll have supporting documentation that stands up in court. This reduces risk both for your business and for your lender. In fact, many businesses will continue to use these processes even when their factoring arrangement ends.

If you don’t want the lender chasing the unpaid invoices, CHOCCS essentially offers a factoring solution where the Client Handles Own Credit Control Services. Confidential factoring is another option, or if your business fits the criteria, you can look at invoice discounting, which is completely confidential.

Whatever the facility you choose, our experience with lenders is that they aren’t too intrusive as long as you provide regular (usually quarterly) management information.

Another worry for business owners is that invoice factoring will prove addictive – once it’s set in motion, it may prove difficult to stop and you’ll get trapped in a cycle of debt.

In our experience, however, the reality is that a factoring facility can be wound down just as you would a bank loan – you’d simply draw down less money per month. The advantage here (over a loan repayment) is that you don’t have that critical fixed payment to make each month, so if money is tight you can just roll back on the facility rather than defaulting on a loan.

3. The liabilities stay with you

Although many descriptions of invoice finance revolve around ‘selling’ your accounts receivable, this can be misleading. If a customer doesn’t pay their invoice during what’s known as a recourse period (usually 90 to 120 days), the lender will pass the unpaid invoice back to you and its funding is removed.

One solution to this issue is bad debt protection, which is included in many lenders’ fee structures and mitigates the risk of customer non-payment. Another is a non-recourse factoring agreement, in which financial responsibility for non-payment lies with the funder.

As specialist invoice finance brokers, we work with clients to find the most advantageous solution for them, whether that’s factoring, invoice discounting, or another finance product. We make our money on commission from the funders, so you don’t pay us a penny.

Talk to one of our invoice finance specialists today.