What is factoring?
Factoring is a financial tool for companies to improve liquidity and conditions to expand. Factoring is a collective term for invoice finance and invoice purchase services.
Depending on among others customer structure, debtor’s payment behaviour, liquidity needs and creditworthiness, you can choose several types of factoring when selling your invoices to a factoring company (factor).
Factoring – invoice financing and invoice purchasing
Typical factoring customers are small to medium-sized enterprises, known as SME’s who quickly need cash. But in recent years, large companies started using factoring companies to improve their cash flow.
What is the difference between invoice purchasing and invoice financing?
Companies can sell their invoices to a factor or encumber them at a financial institution.
What is invoice purchasing?
If you choose invoice purchasing as financing method, the factory company you hired to purchase your invoices will take over the risks related to the purchase which you will be released of to some extent. The factor will be liable to get paid correctly.
What is invoice financing?
Means that a company mortgages their invoices at a financial institution or bank (loan-to-value rate is usually 70-90% of the amount of the invoice). The company must notify its customers about the invoice transfer. The customers’ payment will be paid to the financial institution according to the transfer agreement. The company will be informed by the financial institution when the payment is made.
How much does it cost to sell invoices or bills?
When a factoring company calculates their factoring rate, they take into account several parameters.
Which parameters can affect the cost of factoring?
- Risk assessment
Invoice seller’s creditworthiness and the quality of the accounts receivable.
- Type of factoring
- Number of customers, invoice volume and required services.
- Expected factoring turnover.
- Payment terms
The longer the payment cycle between invoice seller and their customers, the higher the risk for the factoring company
- Contract duration
The longer the factoring contract, the better factoring rate as a longer contract will give higher certainty for future income.
If the seller’s stability improves, the risk situation for the factor will improve.
- Quality of accounts receivable
The factoring rate is the result of risk assessment, type of factoring, internal administrative fees and profit margin. The percentage charged by the factoring company is usually 2 – 5 % on the total invoicing amount. Please note that there may be extra hidden charges as well (see below).
An example of a 5 % fee on the invoice amount: if a factor buys your company’s invoice valued 10 000 GBP. As customer of the factor, you will receive 9500 GPB, the value of 95% of the invoice. At the end the factor earns 5 % of the invoice value by buying it from you equalling 500 GBP.
What is creditworthiness?
Credit worthiness is the assessment of how likely a borrower will default their debt duties.
To determine credit worthiness financial institutions rank persons, companies and countries in credit ratings or credit scores.
Which credit ratings are there and what do they mean?
Credit rating, credit score and credit worthiness are basically the same.
The current classes of credit rating have different scales depending on who they are assessed by. There are scales from AAA to C, where AAA is best and from 1 to 5, where 1 indicates high riks and 5 indicates low risk being best.
- AAA Highest Creditworthiness.
Can only be obtained if the company has a turnover exceeding 200 000 GBP, has been trading for at least 10 years and is able to show financial ratios well in excess of the industry average.
- AA Good Creditworthiness.
Awarded to companies which do not reach the criteria for highest creditworthiness.
- A Creditworthy
Means that the company is creditworthy and can obtain credit lines.
- B Credit rating
Means that the company shows financial ratios under the industry average or other negativ credit information .
- C Lowest Creditworthiness
This means the company has serious paying problems, filed for bankruptcy or shows financial ratios well under the industry average.
- (-) minus sign.
There is insufficient credit information on which to base a rating , even inactive companies receive the rating minus sign (-).
Fixed and variable (hidden) factoring charges
To sell invoices can be a simple and smooth solution to optimize the company’s cashflow. But many factoring companies add hidden fees with a non-transparent price structure.
The rates quoted by factoring firms are excluding VAT, so you will receive less than you think. In case of an unpaid invoice by your customer, you will lose even more money as they will charge interest.
The most common factoring fees
- Fixed fee on the invoicing or interest calculation on the funding amount
- Overdraft fee (comparable to limit fee on an overdraft)
- Risk cover charge on turnover, especially for Non-recourse factoring.
- Handling fee per invoice
- Reminder fee
- Collection fee
- Customer credit limit fee Each debtor (customers of the invoice seller) is assessed by the factoring company.
What is the difference between Recourse and Non-Recourse factoring?
As company you can choose to sell your invoice with or without recourse. It is important to understand the difference.
What is Recourse factoring?
Recourse factoring means that the factor sells back the receivables to you if still unpaid after a certain number of days or after due date. If you, the client can not pay back your debt, the factoring company has the right to collect the debt both from you as from the debtor.
What is Non-recourse factoring?
Non-recourse factoring also called”American Factoring” means that the factor buys your invoices and takes over the credit risk if the debtor can not pay.
Long-term contracts and reduced asset
It can be difficult to get a clear picture of how much factoring will cost. As factor client you risk to be locked into an unfavorable agreement which forces you to sell your approved invoices during the contract period at a price predetermined by the factoring firm.
Once you signed a factor agreement, they no longer need to compete with other factoring companies and can therefor raise the prices without your approval.
Many factoring companies also require that you, your partners and sometimes your spouse sign a personal guarantee . Unpaid sold invoices can then lead to (personal) bankruptcy.
Does selling invoices suit your business?
If you choose to sell your receivable it will indicate that your company is in need of money. Customers can view your company as financially unstable.
On the other hand factoring creates fast money which results in a positive cashflow and you no longer need to worry about late customer payments. The credit risk reduces, you save time and cost on invoice handling and get more time to focus on your core business.
Billhop as alternative liquidity solution
For small and medium-sized companies, liquidity often means an obstacle for growth or capital investments. As business owners you are forced to cut down on investments or find other financing.
With Billhop companies can use their corporate card to extend payment terms in order to free up working capital. Billhop is a safe and secure alternative to factoring. We do not charge fixed cost and have no fixed contract period. There are no extra charges, only a percentage on the invoice amount which you choose when using the service
Billhop only has one fee, regardless of the company’s credit rating
When you receive a high credit ranking, your financial situation is good and you handled your previous credits. In case of a bad financial status you are considered to have a lower credit ranking and to – most likely – mismanage future credit. Unlike the factoring company which bases their rates on your credit rating, our fee is always the same regardless of your company’s credit rating.
By paying your supplier’s invoices via Billhop, you will receive 30-60 days extended payment terms. This is often 30 days more than most factors offer and you maintain a good relation with your customers since you don’t need to sell your invoices.
It is easy to compare your cost at Billhop (2,9 percent of the invoice amount) which gives you 30-60 more payment days (depending on the duration of your interest free period on your credit card) to the cost by a factoring service for the corresponding payment period).
Please contact us at Billhop
For more information about Billhop and how we can improve your company’s cashflow by taking advantage of the interest free credit period on your credit card, do not hesitate to contact us or to send us below form with your contact details and we contact you at your convenience!
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