How debt factoring works

How debt factoring works

Factoring provides a fast prepayment against your sales ledger. It allows you, at a cost, to flexibly increase your working capital and improve cashflow.

Factoring is offered to businesses trading with other businesses on credit terms. It is not normally available to retailers or to cash traders.

When factoring starts
Factors can be independent, or subsidiaries of major banks and financial institutions. Whatever their background, they will want to meet you, visit your business, review your financial situation and study your business plan to evaluate your suitability for a factoring facility.

Credit limits might be required - if so, you must agree how they will operate.

After signing the agreement, the factor will typically agree to advance up to 85 per cent of approved invoices. Payment is usually made within 24 hours. Usually all sales go through the factor.

Check the notification period - most factors require three months' notice to end the service, but some require longer. Negotiate if you are not happy with the notice period.

Factoring is a complex, long-term agreement. It is advisable to consult your solicitor on the legal and financial implications of factoring.

When an invoice is raised
You raise an invoice, which has instructions to pay the factor directly and send it to the customer. Send a copy of it to the factor.
The factor pays an agreed percentage of the invoice to you.
The factor issues statements to the customer on your behalf. It operates credit control procedures including telephoning the customer if necessary.
When an invoice is paid by the customer
The customer should pay 100 per cent of the invoice directly to the factor.
The factor pays the balance of the invoice to you. Fees and interest will be deducted from the payment. See the page in this guide on the cost of factoring and invoice discounting.
When an invoice is not paid
If an invoice is not paid, responsibility for paying the debt will depend on the type of agreement - either recourse factoring or non-recourse factoring. See the page in this guide on recourse factoring and non-recourse factoring.