A consistent cash flow is vital for your business to continue running smoothly. If your customers fail to pay the invoices you send or take a long time to do so, this can interrupt your cash flow and cause serious problems. If you’re having issues with getting invoices paid on time, you might consider debt factoring as a solution.

This article will explain what debt factoring is and how you can use it. We’ll also cover a few other topics, including:

  • What is debt factoring?
  • How can I use debt factoring?
  • What are the advantages of debt factoring?
  • What are the disadvantages of debt factoring?

What is debt factoring?

Say your business provides a service to another organisation and then sends an invoice. Unless you agree to a specific payment date, the invoiced party has a legal obligation to pay you within 30 days

Although this means you have a degree of security knowing you’ll receive payment within that time frame, 30 days can be a long time. If your business is struggling, you’ll be especially interested in getting your payment as soon as possible. This is where debt factoring comes in.

Debt factoring is another way of collecting invoices. Here’s a step-by-step explanation:

  1. You provide a service to another individual or organisation and send them an invoice.
  2. You contact a third party and send a copy of the invoice.
  3. The third-party pays you the majority of the amount on the invoice (usually 90%).
  4. The third-party collects the money the debtor owes.
  5. You receive the remaining amount on the invoice minus a factoring fee taken by the third party.

How can I use debt factoring?

If you have several unpaid invoices, and your cash flow is suffering, you might consider debt factoring. To take advantage of this process, you’ll need to approach a debt factoring company.

You can sell all of your outstanding invoices to the debt factoring company or a portion of them — your choice might depend on the size of the invoices and how much money you need. Once you sell the invoices, the debt factoring company will perform a credit check on your debtors. This is so they can find out how likely the debtor is to pay the invoice. 

Once they do the credit check, the company will draw up a contract between you and them. Make sure you check the following three points: the amount the debt factoring company will pay, how much of a fee they’re going to take out of your invoice, and who is responsible for paying if the debtor cannot pay. 

The money a factoring company pays you is similar to a loan, in that they pay you with the expectation that the invoice they’re collecting will make their money back. If the debtor does not pay, though, it becomes someone else’s responsibility to pay off the invoice. 

It may be that the factoring company takes the loss, but it may be that you need to pay off the invoice to clear the debt, so read any factoring contracts carefully.

What are the advantages of debt factoring? 

Saves time

Instead of having to worry about late-paying customers or how to ask about payment without being pushy, you can sell off your invoices and have a debt factoring company take care of everything.

When you’re a small business owner, time is an enormously valuable resource. Using debt factoring can free up the time you would spend chasing invoices to use on other important jobs. 

Improves cash flow

The primary reason that businesses use debt factoring is to improve their cash flow. Instead of waiting for a full invoice to come in, you can almost immediately receive a large portion of it from a debt factoring company.

On top of that, you’ll later receive more money from the debt factoring company when the debtor pays the invoice. The multiple payments and the speed at which money changes hands makes debt factoring great for businesses with poor cash flow. 

What are the disadvantages of debt factoring?

Reduced profits

Debt factoring companies take a percentage of your invoice for themselves. This is usually a small percentage (around 3-5%), but it can turn into a substantial amount in larger invoices. 

In small businesses, every penny counts. You may have concerns about how long it will take for a debtor to pay an invoice, but consider how much of the invoice you need to keep your business running. If that 3% is going to make a difference, debt factoring may not be for you.

 Loss of control

When you use a debt factoring company, they’ll take charge of the whole payment collection stage of a customer transaction. As the customer knows that your business is the one they owe money to, they’ll likely see the factoring company as an extension of your company.

So if the factoring company takes drastic measures to collect the invoice payment, or is rude during the payment collection, it will reflect badly on your company. Debt factoring means you lose control over your company’s image during payment collection, which can have severe consequences.

Manage your cash flow effectively

Although they can be useful, it’s good to keep a steady cash flow so you don’t need to rely on debt factoring. The key to a good cash flow is keeping track of all your company’s financial transactions, and having them all easily accessible from one place. A great way to achieve this is to use the Countingup app.

Countingup is the business current account with built-in accounting software that allows you to manage all your financial data in one place. With features like automatic expense categorisation, invoicing on the go, receipt capture tools, tax estimates, and cash flow insights, you can confidently keep on top of your business finances wherever you are. 

You can also share your bookkeeping with your accountant instantly without worrying about duplication errors, data lags or inaccuracies. Seamless, simple, and straightforward! 

Find out more here.