Raising company finance - what is factoring and invoice discounting?
by: derekc
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In the current economic downturn with many banks' unwillingness to lend, businesses are struggling to raise money to finance their activities using traditional sources such as an overdraft, credit card or loan facilities. For this reason, many companies are turning to sources of income such as factoring and invoice discounting.
With factoring and invoice discounting, cash flow is improved by borrowing against invoices. A company which is taking advantage of this type of facility will normally be able to gain access to 80% of the value of the invoice raised immediately without having to wait for the normal payment period. There are three main ways to do this:
- Invoice Factoring
- The process of invoice factoring generally involves a bank (normally known as the Factoring company) taking over a company's invoicing and credit control function. When invoices are raised, the factoring company immediately makes credit available to the company. The name of the factoring company is stated on the invoice and the payment of the invoice is made directly to the factoring company. The factoring company will often manage payment collection and credit control.
- CHOCCs Factoring
- CHOCCs stands for Client Handles Own Credit Control. This type of factoring is similar to full factoring however in this situation, the company still retains responsibility for collecting payment of its invoices. The advantage of this for the company is that it will normally be a cheaper service and more control is maintained over the payment relationship with the company's clients.
- Invoice Discounting
- Invoice discounting is similar to factoring in the sense that a factoring company will make credit available to the business as soon as an invoice is issued. But in this case the service is much more discreet. The company sends out invoices and collects payment in the normal way, but the factoring company's name does not appear anywhere and debtors will therefore be unaware of their involvement.
Which factoring option should you use?
This depends on the nature of your business. For example, where it is important to ensure that the involvement of a factor is not disclosed, invoice discounting may be a more appropriate method. Where this does not matter or in fact where it is seen as an advantage to involve a third party to help in the collection of debts, then full factoring may be the correct solution.
It should be noted that Invoice Discounting is seen as a bigger risk by the factoring company as it must have the confidence that the business it is lending to will tightly manage its debt collection processes. Because of this smaller amounts than the 80% of invoice value are likely to be made available up front by the factoring company.
Invoice factoring or discounting is an ideal way to improve cash flow based on business already happening, and for it to work the business has to be raising invoices. However it can also be an ideal solution to help improve the cash flow position of a new business such as a Phoenix company. Here invoices will start to be raised almost immediately and so a factoring facility could be used.
Because Invoice factoring or discounting focus on cash flow improvement, they are not generally regarded as appropriate methods of raising a lump sum for a specific business project. If this is your requirement and a bank loan is not available, then a more suitable option may be asset refinance.
Invoice financing and discounting are not without cost. Normally both options involve a service charge (which may be between 0.5% and 1% of the sum lent) and a rate of interest. However, where a business is looking to improve cash flow and more tradition methods of achieving this such as bank overdrafts and credit cards are being withdrawn, invoice financing and discounting is often an extremely useful solution.
About the Author
Derek Cooper is Managing Director of Cooper Matthews Limited.
If your business is need of some additional cash flow, but traditional loan sources have been denied you then look at http://coopermatthews.com/business-refinancing.html.
Derek's experience of both corporate insolvency and business management puts him in a position to be able to understand the challenges facing businesses in today's economic climate.
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