Improving cash flow with factoring or invoice discounting?

What is invoice factoring and invoice discounting and how can it help my business cash flow?

Invoice factoring and invoice discounting are both types of funding facilities that help generate cash. This cash can then be used for a variety of reasons, but typically the main ones are:

To fund working capital requirements – if your business is growing then the facility should grow in line with your revenue growth (and therefore assist with your increased working capital requirements). In addition, if your businesses cashflow is particularly seasonal, the facility can be utilised when required to smooth out seasonal cash requirements, similar to how you would utilise a traditional overdraft facility.
For transactions – often buyers of a business will seek to use a facility such as invoice discounting or invoice factoring and use the cash raised to help fund buying the business off the current business owner.
For investment – businesses can use the cash to invest in developing the business.

What is the difference between invoice factoring and invoice discounting?

The fundamental difference between invoice factoring and invoice discounting is that generally with invoice factoring your customers will know you are using the facility. With invoice discounting the credit control process is generally left with the business and therefore the use of the facility remains unknown to your customers. If you have a close or sensitive relationship with your customers, you may prefer to use a facility that doesn’t potentially affect that relationship.

Invoice factoring and invoice discounting work in a practical sense towards cash flow

Both facilities have a similar process whereby your business will essentially “sell” its own sales invoices to the funder. The funder then almost immediately ‘releases’ cash to your business with the cash released having a value of typically 80-85% of the invoiced amount. The remaining 15-20% of the invoice (minus fees for use of the facility) is then ‘released’ when your customer pays the invoice amount in full.

Business cash flow advantages of invoice factoring and invoice discounting?

The main advantage is that both facilities help businesses cash flow by freeing up cash very quickly and allow a business to use 80-85% of the cash immediately rather than waiting for your customer to pay. It fills the gap for a short term need for cash. It is a ‘revolving’ facility that only fluctuates with the size of your debtor book – it requires no capital repayments, and in that sense, you can think of the facility as similar to an overdraft or an interest only loan.

What are the disadvantages of invoice factoring and invoice discounting?

One of the disadvantages is that criteria for obtaining this type of funding may not be suitable for some businesses. If your business has very few customers, invoices linked to longer term contracts or a significant proportion of invoices relating to export sales, then you may struggle to be eligible to fund some or all of your debtors (or you may need to speak to a specialist lender in this area). Once the facility is in place, there is also an ongoing administrative burden placed on business owners compared to a traditional loan.

Shorts Advisers in Corporate Finance seek to make sure our clients use the correct type of funding for there business cash flow needs. If you would like to know more please contact us.