1. Is Invoice Factoring Right For Your Small Business?
If your business, like many others, has debtors that pay on terms, you don’t have to be stuck without cash flow. Invoice discounting — where you sell unpaid invoices to a factor and get access to cash immediately — could be the answer to your troubles.
2. The Basics of Invoice Factoring
Factoring is used to gain access to cash when your debtors pay on terms. Instead of waiting 30, 45 or 60 days for a customer to pay, small businesses can sell their invoices to a factor and get the cash needed to grow their business operations or fulfill new orders
3. But how does factoring actually work?
The factoring company will give you 80% to 95% of the face value of the invoice upfront; when the customer pays, the company will send you the reserved money, minus a factoring fee. A normal factoring fee (or discount rate) ranges between 1% and 6% per month. Fees can be accrued daily, weekly, or monthly, so the longer your customer waits to pay, the larger your accrued factoring fee becomes.
You sell an invoice valued at R 500 000 to a factor. The factor advances the amount of R 400 000 to you (80% of the invoice value) and keeps R 100 000 on reserve. Your factoring fee is 0.2% per day. Your customer pays after 35 days, so your fee is R 400 000 x 35 x 0.2% = R 28 000. The factor deducts the fee, and sends the remaining R 72 000,to you.
5. What is the difference between Recourse and Non-recourse Factoring?
Invoice discounting is a effective tool to ensure positive cash flow in your business, but what happens if your customer doesn’t pay their invoice? That will depend on whether you have a recourse or non-recourse factoring arrangement:
Recourse: You are entirely responsible for re-purchasing the unpaid invoice.
Non-recourse: The invoice factor is responsible for the unpaid invoice. Source Growth fund does recourse factoring.
6. What is the difference between Spot Factoring and Contract Factoring
Spot Factoring: You offer the invoice you want to sell to the factor and they choose which invoices they want to buy. Use it as you need it.
Contract Factoring: Where you agree to a long-term contract to sell all of your invoices to a factor. The factor takes over the administration of your debtors book
There are pros and cons to each option. Spot factoring allows your business to factor an invoice without entering into a long-term relationship with the factoring company, once it’s paid the contract comes to an end. Spot Factoring does often involve higher factoring fees.
7. Who offers invoice discounting in South Africa?
Invoice discounting in South Africa has been around for many years. It is offered by a small number of specialist financiers. Each factors product offering differs from the others. Some are more suitable for small businesses and some for larger businesses. Some factors prefer certain industries.
8. What are the advantages and disadvantages of invoice discounting?
The most important advantages of invoice discounting are that it can be implemented quickly and that it can sometimes be the only way for a smaller business to raise finance.
A business’s debtors book is an important asset on its balance sheet which is usually funded by its own capital. When it runs out of working capital, the small business will experience major cash flow problems and may even be liquidated. Invoice discounting can save a small business from disaster.
Invoice discounting is a more expensive way of raising finance than commercial bank funding, but it may often be the only solution. Invoice discounting should therefore be considered when normal bank funding cannot be obtained. From a cost perspective, it is comparable to granting a cash settlement discount to debtors.
9. What is disclosed invoice discounting?
Disclosed invoice discounting refers to the debtor being aware that its supplier has discounted its invoice to a factor.The supplier, debtor and factor work together, so that the debtor’s good credit standing can be used to raise funding for its supplier.Typically the debtor would verify the validity of the invoice to the financier and would also pay the invoice amount directly to the financier on the due date.
Disclosed invoice discounting is ideal for a smaller business with a few large debtors but lacking an established track record itself. It is therefore ideal for start-ups who have been in business for a few months.
10. What are the requirements for invoice discounting?
- The product or service must have been delivered or rendered already;
- The debtor must be satisfied with the product or service;
- The debtor must have a good credit standing; and
- The invoice must have been issued.
11.What are invoice factoring costs?
Invoice factoring costs typically vary between about 1% and 6% per month.Sometimes the costs are fixed for a month, e.g. the cost would be 5% irrespective of the actual time it takes before the debtor pays.In some cases the costs are calculated on the full amount of the invoice and in other cases the costs are calculated only on the portion which is actually advanced to the client.
Sometimes a minimum monthly fee is charged even if no debtors are factored during that month.
Small businesses which are considering invoice factoring should ensure that they understand exactly how and when fees are charged and calculated by potential financiers so that they can make informed decisions.
12. What are the benefits of invoice factoring?
The major benefit of invoice factoring is that an asset on the balance sheet which is sometimes overlooked, i.e. the debtors, can be used to raise finance.
This is especially true if banks are not interested in funding the business because they see it as “too risky”.
In some cases the business may also want to outsource the management of its debtors book to a professional outfit such as a factoring house. Although this usually not cheaper than managing the debtors in-house, it may be more efficient.