Factoring and Invoice Discounting both enable businesses to receive cash advances based on the value of their outstanding invoices to business customers. Funds are usually advanced for periods of 30-90 days and providers will normally insist on financing all the invoices a company issues, meaning that the quantity of borrowing available will tend to increase as the borrower's revenues grow. In the case of Factoring, the finance provider will undertake credit control and collections on behalf of the borrower, while in Invoice Discounting, these functions remain with the borrower.
The Informed Funding two-minute guide: Invoice Discounting and Factoring
- What are invoice discounting and factoring?
These are two related forms of short-term funding under which companies that sell to other businesses – rather than individual consumers – can raise finance based on the value of their outstanding invoices, or “accounts receivable”. The main difference between the two is that in factoring the finance provider will take over responsibility for credit control and collections from the borrower, while with invoice discounting the borrower remains responsible for these functions and therefore retains a direct credit relationship with its customers.
- Who decides which one I can use?
This usually depends on how large and well established your company is. In general, invoice discounting will be offered only to companies with annual turnover of more than £500,000 that can demonstrate they have sound financial systems and procedures and an established credit control function. Smaller companies with sales of £50,000-£500,000 a year will be offered a factoring facility.
- How much can I borrow and for how long?
Funding based on accounts receivable, whether factoring or invoice discounting, is usually an ongoing facility that runs for periods of 12 months and upwards. Once a sale is invoiced, funds are advanced against that sale for periods of between 30 and 90 days, in line with the typical payment terms agreed with business customers. The size of facility the borrower can access will depend on the size of its receivables book and what proportion of the book is deemed as “eligible assets” by the funder. Invoice discounting facilities usually enable the borrower to receive 85%-90% of the value of outstanding invoices, while factoring clients usually receive 80%-85%. The borrower receives the remaining portion when the customer settles its bill, but must allow for charges owing to the funder that provided the advance.
- What security do I need to provide?
Factoring and invoice discounting are secured via a floating charge placed on the whole sales ledger by the funder. In some cases, borrowers may also be required to provide a personal guarantee.
- What does it cost and what fees are payable?
Borrowers will be charged a one-off arrangement fee when they set up a factoring or invoice discounting facility. There will then be a monthly fee, either a fixed amount or a percentage of turnover (around 0.5% for invoice discounting, 0.75%-2.5% for factoring). Finally, there will be a finance charge based on the sum advanced and calculated on a daily basis (typically 1.5%-3% above the base rate in both cases).
- What happens if my customer doesn’t pay the invoice?
Unless you have taken out credit insurance, which may be offered by your invoice discounter or factoring house, your company will remain liable for repaying any sums owing to your lender in the event of non-payment by a customer.
- Need to know:
- Invoice discounting and factoring facilities have the advantage that they grow with the company’s revenues so that the amount of funding will tend to increase in line with sales. Equally, if your sales decline so will the amount of funding available to you.
- Since funding is linked to sales rather than the state of the balance sheet, invoice discounting and factoring can be accessible for loss-making businesses.
- Funders may charge a range of fees over and above the basic charges set out above. These can include fees to carry out an audit of a potential borrower’s accounts before granting a facility and “refactoring fees” if an invoice becomes overdue.
- Funders may also impose limits on how much they will advance against sales to particular customers, especially where that customer accounts for a large percentage of your total turnover.
- Businesses that have long-term contracts, staged payments or contracts with retention clauses built in are unlikely to be suitable for these forms of funding.
- You should pay attention to the notice period in an invoice discounting or factoring facility – usually it will be three months but it can be up to year.
The accounting treatment for invoice factoring will depend on the risks and rewards that the entity retains. In some situations it will be appropriate to derecognise the receivable along with the liability to the factor.
The tax treatment will typically follow the accounting treatment. Debt write offs and interest charges made to the accounts would be tax deductible,
From a VAT perspective, a factor cannot claim bad debt relief for debts assigned to him by his client. The client cannot claim bad debt relief for a debt assigned to a factor but can do so if the factor re-assigns the debt to him.