Invoice factoring sounds like the perfect solution to a small business. Be careful though, my recent experience shows that, in some situations, this may actually be quite detrimental to the cash flow management of your business.
Firstly though, are we all clear on what is invoice factoring?
Invoice factoring takes over all the tasks involved with the running and maintaining of your sales ledger. This covers the tasks of raising your invoices to customers, payment collection and credit control. Furthermore, the factoring company will advance you upto 95% of the value of the invoices raised.
Unfortunately if the factoring company starts to find that your customers are not paying within a set amount of time or they don’t “like” the customers you are dealing with, then they may start to cap your factoring advances. When your funds start to get capped and with no alternative arrangement in place, your cash flow will be instantly stopped and you could find yourself in a very difficult and stressful place.
So, think about your business now and try to manage this situation before the situation starts to manage you!
Here are 3 areas you should think about and how they apply to your small business accounting.
1. You lack visibility of your sales ledger process so will be dependent on Invoice factoring
The problem: Managing your customer invoicing and cash income may seem like an onerous and non priority task to you, especially if you want to be able to focus on growth. Invoice factoring can be a great solution, especially where your costs are heavily incurred upfront, e.g temporary staffing agencies. However, with handing over this processing task to a third party you will loose line of sight and visibility on who are the bad payers, how long is your cash collection cycle and what is the true requirement for working capital for your business. In the early days of your business, this may not be your concern, however as your turnover increases, factoring charges based on your gross turnover will increase proportionately. 4% of £100K may be affordable, 4% of £2m feels expensive.
To manage this situation: Think how long and at what level of turnover the factoring costs, in real terms, will become uncompetitive. Ensure you plan in advance an alternative financing strategy. Look at the terms of your agreement to ensure you will have the option to switch when the time is right and don’t tie yourself in for too great lengths of time on the promise of a lower factoring % today.
2. Slow responsiveness to queries and credit note requests.
The problem: Is it likely that customers will dispute or query invoices due to the nature of your business? Where a large factoring service is used, this will be remote to your offices. Any customers ringing up with queries are likely to be dealt with, in a less personal way than if this function were carried out in house. Customers with queries on invoices often find they don’t get a quick level of response for copy invoices or even agreed credit notes. This all results in payments being held back. Once again, this is going to impact on your advance if your agreement is that you are advanced up to a capped amount based on the age and balance on your sales ledger.
To manage this situation: Check the responsiveness of the factoring company by ringing them yourself. Do you feel happy that your point of contact is responsive to your queries as their customer? Is there cover when your point of contact is not about? If they are not responsive to you, you can bet your customers are getting an even worst service. Check also on the ledger notes and with your contact periodically. What types of queries and requests are being raised by your customers? This can give you an indication of where the process is failing. E.g are customers constantly asking for copies of invoices, could this indicate that invoice are not being sent out in time if at all. Check where you have requested a credit note, how long is it taking to get this credit note raised and you seeing it on the system. What is the principle way invoices and supporting documents are being sent to your customers, post or email and how long is this taking.
3. You have new customers who do not have sufficient trading history.
The problem: Factoring companies really do not like new companies in terms of granting advances on their invoices. With no trading history, they may simply decide not to factor these invoices but will happily take on the invoicing and credit control of these customers. This will all be wrapped up in your fee, so ensure that you understand the factoring company’s criteria for factoring a company for you. If you are paying for credit control, satisfy yourself that the factoring company is chasing your unfactored invoices as vigorously as your factored invoices.
To manage this situation: If there are going to be a number of your customers who are likely to not be factored, then it may be worthwhile you taking on your own credit control of your customers. In terms of the management of your cash, these customers will be critical and will probably need much closer watching until you are satisfied they will pay to terms and will not make an unnecessarily pull on your cash reserves.
Otherwise, check the processing time it takes for your Factoring company to raise, send out and collect payment from your unfactored invoices. Check the lead time your invoice factoring company believes it can work to. Now check with the customer on how quickly they are receiving the invoice. With some of the larger factoring businesses, they do not know themselves so don’t always rely on what they are telling you, carry out your own checks.