Why Factoring

Why (and when) factoring?

More businesses fail through lack of cashflow than for any other single reason. Paradoxically the very success of a business in achieving turnover may often bring about its downfall when its resources are strained beyond breaking point by the need to finance the sales. This may sometimes even be the case when a business is trading profitably when the profits are locked up in assets such as debtors and stock

The real dilemma for a business begins when successful sales invoiced monthly do not produce cash on time to pay the wages or creditors.

So what options does a business have at such a time?

Traditionally the first option for a business will be a bank overdraft. With interest rates currently relatively low this will undoubtedly be the cheapest form of finance. However, the bank will principally judge a business on its historical performance rather than its future expectations. Even when the bank accepts the validity of projections it is likely that outside security will be required to reinforce the manager’s personal judgement and approval.
A bank overdraft will also be repayable on demand and can theoretically and in practice be withdrawn without notice. Most businessmen have heard horror stories about businesses failing through an overdraft being withdrawn. To these can be added the current bank predilection for withdrawing or reducing exposure wholesale from industry sectors following unfavourable comment or experience.
However, factoring and invoice discounting can provide the key to unlocking the result of a successful sale – the sales invoice.

Provided that the invoice meets the requirements of the factor and the business is perceived to be sound then immediate cashflow can provide a solution to the businesses’ problems.

In addition, a factoring agreement is contractual and not repayable on demand and is subject to a notice period from either party.
The main benefit to factoring can therefore be seen to be the ability to have the cash available to fund the next order, regardless of whether or not payment has been received for the last one.

Factoring can be a solution in many cases but will be most appropriate for rapidly expanding businesses, management buy-outs, acquisitions, restructures and where traditional bank overdraft facilities are inadequate. The appetite for start-up businesses is more muted but several of the factoring companies will consider new businesses.

Certain of the factoring companies have minimum sales turnover criteria for new clients although again the smallest company will probably find a home for its business if it looks sufficiently hard.

Some 50% of the lending of factoring companies is to the asset-rich manufacturing industry. However, other industries will also benefit including:

• printing,
• engineering,
• temporary labour hire,
• PCB manufacture, haulage,
• food and general distribution,
• wholesaling
• simple service businesses.

The list of all the suitable candidates is too exhaustive to mention but more “difficult” industries will include the building and construction industries, bespoke computer businesses and any industry that relies on stage payments and interim invoicing.

Of foremost importance for an industry that relies on the debtor as much as if not more than the borrower for repayment is the contractual nature of the debt and the status of the debtors.

Most favoured will be “sell and forget” products or services with no warranties or guarantees, no retention of title by the original supplier on the goods being sold, in turn sold to a number of well spread and financially sound debtors in mainland UK. Export factoring is possible but not through all the factoring companies, a number of which will accept a limited number of overseas clients only under sufferance.

Having set out the “ideal” factoring client it is also right to point out that one of the greatest strengths of the factoring industry – in particular the smaller independent factors – is its unwillingness to be prescribed and to conform to rigid rules. It is therefore quite conceivable that a sufficiently sound business will overcome some of the above less favoured features and still find someone willing to offer factoring where others would look on the proposal less favourably.