You have an SME and you have run into a few cash flow problems. Your company is doing well: sales are up, and you are taking bigger orders. However, you feel a bit overstretched at the moment. You need to pay your employees’ wages at the end of the month You can’t delay paying your suppliers for much longer. You just need to get through this rough patch and you will be fine once you get paid for the orders you have already filled and delivered.
This is a situation that many companies face, especially new companies. They run into a cash flow problem for the first time, and they have neither a line of credit set up at a bank or an alternative source of funds available to draw on when liquidity is squeezed.
They are faced with the situation of having to find cash just to keep the company going until an invoice is paid. Invoices have terms of payment of 30 days, 60 days or 90 days. Those days until payment can tick by surprisingly slowly when bills need to be paid.
What are the Options?
Bank Loan – This is the cheapest source of funding. The percentage of interest is determined by the bank who will follow the interest rates set out by the central bank. Since the financial crash of 2008 bank interest rates have been low, but they have been rising steadily due to economic disruption caused by Brexit, Covid-19 and the war in Ukraine.
There are two main drawbacks to a bank loan. Firstly, they need to be approved. Banks do things in their own time, following their own procedures. If you need cash urgently you might find the bank loan option as too slow and unwieldy to be of practical use. Moreover, a bank will want the security of collateral to risk extending credit to a company. If the loan is not repaid in full and on time, a company could forfeit valuable assets like machinery or commercial property.
Invoice Finance – This is a more expensive source of funding than a bank loan. The advantages of invoice finance are myriad. Invoice finance allows a company to use unpaid invoices as collateral to get credit. It is a flexible approach to securing credit. A good invoice finance company will be able to offer various options to a potential client. The most common arrangement is factoring. In this set-up, a company signs over an unpaid invoice to a factoring company. They will immediately pay the company 70% to 90% of the face value of the invoice. The factoring company will then receive the full amount from the debtor when the period for paying an invoice has expired. At this point they deduct their fees and send the remaining amount to their client.
So, no company assets are risked in securing early funding. A factoring firm has expertise in assessing credit worthiness. They won’t risk factoring an invoice if they think it has a poor chance of being paid. And if there is a problem with payment, a factoring firm will have a team dedicated to chasing up late payers, and if necessary, pursue legal avenues to recover unpaid debt.
Which Factoring Firm?
To return to the opening scenario, you are the CEO of an SME and you are struggling to pay the bills while you are waiting for payment from customers. You have looked at the options and have decided to approach a factoring company. Below is a list of things to consider.
- Location. As you will see, from our directory of factoring firms there are plenty of options. However, they are not distributed evenly throughout the world. Some factoring firms take on clients from around the world, others are country specific.
- Industry. Some factoring firms focus exclusively on one sector of the economy, such as building, clothing or commercial logistics. A factoring company with knowledge of sector specifics is a major advantage. They can use their expertise to help you choose the right factoring arrangement for you.
- Type of factoring. You have to consider the type of factoring arrangement that best suits your business. You can get non-recourse factoring where the risk and collection of the outstanding invoice payment is taken over completely by the factoring firm. They own the invoice and will make their own judgements on whether to start legal proceedings for late or non-payment. Recourse factoring leaves the invoice in question under the legal responsibility of your company. There is also the option of reverse factoring where you initiate the financing process for your suppliers to get early payment on invoices that they have raised against sending supplies to you. That is another solution to cash flow issues.
- Fees. The old adage of buyer beware applies to choosing a factoring firm, especially when it comes to fees. Some companies just quote their headline fee for factoring and put in extra fees in the small print for services such as invoice processing, chasing up payment and legal fees. Make sure you know the full cost of using a factoring company before committing to a particular provider.
- Accreditation, customer service and reputation. It is wise to look for the accreditation of a factoring company. In America, factoring firms are accredited by the FDIC (Federal Deposit Insurance Corporation). This means the company has insurance in place in case a factoring deal falls through. Good customer service is essential. You want to be continually in the loop. You want to know quickly whether an invoice is deemed legible for factoring and how they assess the credit worthiness of the debtor. You will also want a point of contact to keep you up-to-date with the process of the invoice factoring. For this reason, word-of-mouth recommendations from business colleagues are extremely useful. As are online reviews of factoring providers.
Once you have decided to look into securing funds against unpaid invoices, you have due diligence to do to make sure you choose a factoring company that is right for your company. It is good to seek out a factoring company that has experience of dealing with invoices in your sector.
As with all things in business: don’t sign on the dotted line until you are sure about all the fees. It is also important to research the factoring firms that you are considering using. What type of insurance do they have? What do previous customers have to say about their experiences dealing with that firm?
It is possible to shop around when it comes to factoring firms. Their prices vary as do the services they offer.