Factoring and invoice discounting facilities can be very straightforward to operate. However, there are pitfalls which some factoring companies will not discuss with you until you have signed on the dotted line.
The process in its simplest format is as follows –
- You provide the product or service to your customer.
- An invoice is raised for the completed work which is sent as normal to the customer.
- You upload a copy of this invoice to the factoring companies website.
- The following day you ‘draw down’ up to 85% of the gross value of this invoice into your normal bank account (less the factoring company’s admin fee).
- The factoring company then chases the debt for you to ensure your customer pays on time.
- The payment from the customer is sent to the factoring company’s jointly named collection account.
- You receive the balance of the invoice.
Seems simple doesn’t it? What could possibly go wrong?
Well, in reality, a number of problems can occur. Especially if the invoice finance provider fails to agree on specific points prior to the commencement of the agreement.
So think of the 5 factors below when approaching invoice factoring:
- Set a suitable debtor concentration level
This is critical, as most factors will only fund each debtor to a percentage of the overall sales ledger. So, if you have one very large customer they may restrict the funding on that debtor. We are flexible on concentration limits at Peak with a number of clients having only 1 customer (100% concentration needed).
- What individual customer funding limits are they going to provide
If you do not agree on the funding limits before completing the deal, you may be in for a surprise. As the limit you get may be lower than the balance on that debtor account. This is also known as disapproved funding.
- Bad debt protection
In order to gain the concentration and funding limit you need within your business, the factor may introduce the need to insure that debtor from bad debt risk. This generally incurs a further ‘bad debt protection’ fee, which is not always communicated before the deal is done.
- Renewal fees
Make sure that you are not paying arrangement fees every 12 months to renew the funding line. This type of fee has crept into the industry in the last few years and can be costly. We don’t charge these at Peak.
Some factoring companies will verify random invoices before they pay money out against them. This is not uncommon if the invoice is sizeable in comparison to normal trading patterns. However, the time taken for the verification to be completed can vary significantly. Make sure you check the factoring company’s policy in advance. Or you could find large chunks of your turnover failing to be funded and sitting in ‘verification pending’ accounts.
No invoice finance provider is perfect. But if you have the details of the facility properly explained and if you iron out any future issues in advance it will work far better in the long run for both parties.