Traditionally factoring has been a way of funding internal growth or meeting cash flow demands without having to approach a bank for overdraft funding. Factoring involves selling your invoices to a 3rd party. This means that all your invoices are then sent out with the factoring company's payment details and your customers pay the factoring company directly. In return the factoring company will pay you up to 85% of the total value of the invoices usually within 2 - 3 days. The factoring company will then chase any outstanding debt on your behalf and will charge a fee of between 3 - 5% of the total invoice for this service.

Say for example you own a Building Supplies company. Many of your customers have an account, which they seem to take forever to pay. It's not that they are bad customers it's just they are busy and paying your account slips off their "to-do" list. As a result you have outstanding invoices worth £40,000 and you are experiencing cash flow problems. Instead of seeking a loan to tide you over or increasing your overdraft facility you could sell your invoices to a factoring company.

You could receive a cash injection of £34,000 (85% of the value of the outstanding invoices) very quickly. The factoring company would take over chasing the debt and once payment was made would pay you the remaining balance of the invoice less their fee and interest on the original amount sent to you.

There are two types of factoring, recourse and non-recourse factoring. Recourse factoring means the factoring company will be able to reclaim the money they have already paid you should your customer not pay the invoice. In non-recourse factoring they will not be able to reclaim money from you but they will have insured your debt and will therefore seek payment from the insurance company. Recourse factoring is of course less expensive and may have fewer conditions attached.

Ideal for:
All businesses that transact with other businesses are suitable for factoring. You would preferably have several customers of whom none account for more than 1/3rd of turnover. Normally factoring companies don't like when a company has only one customer.

Security requirements:
Normally factoring is secured against the value of the invoices. Occasionally personal guarantees for a portion of the funds advanced may be required from the directors of a limited company.