Business owners have plenty of options available when it comes to financing their businesses. At White Oak UK, we have plenty of business finance products that can be tailored to help supercharge the expansion of your business.
Debt factoring is a type of business finance used by small-to-medium-sized businesses to access finance that’s tied up in unpaid invoices. The flexibility and fast approval process makes it popular with businesses who are looking to improve their cash flow.
We have put together a guide to help business owners who are looking to access this type of finance for their business.
Debt factoring explained
Debt factoring involves selling the unpaid invoices to a third-party. They will be responsible for paying the business a percentage of the total amount originally charged by the client, as well as collecting the payment from the buyer. Businesses can quickly access the capital they need before the clients pay for the goods or services received.
In terms of how it works, it involves three parties, a business, the client and a debt factoring company. Once the debt factoring company has bought the invoice, the business is paid a percentage of the invoice amount due by the client.
After the client has made the payment, they will release the remaining percentage of the invoice payment. The business will receive that finance, minus a factoring fee that’s deducted by the debt factoring company.
Debt factoring is particularly beneficial for businesses that extend trade credit to their clients; typically businesses that deal with B2B transactions. These companies often face delays in receiving payments, which can strain cash flow. Small to medium-sized businesses, startups and even larger companies with fluctuating cash flow can utilise debt factoring to quickly access capital that would otherwise be tied up in unpaid invoices. In particular, it’s useful for companies that do not want to wait 30, 60 or even 90 days for payments to come through but still need to maintain operations or seize growth opportunities.
Advantages and disadvantages of debt factoring
While debt factoring has many benefits for business owners looking to access instant finance, it might not be the right type of finance for your business. It’s worth doing your research first before you decide to go down this business finance route.
While debt factoring may seem like a loan, it is not one. Instead, it is a financial transaction where a business sells its receivables to a third party for immediate cash. The factoring company takes on the responsibility of collecting payment from the business’s clients. In contrast, a loan involves borrowing money that must be repaid with interest over time. Debt factoring provides a more flexible and immediate solution to cash flow issues but does not create long-term debt like a traditional loan would.
We have put together some of the advantages and disadvantages of using this type of business finance.
Advantages of debt factoring
Improves business’ cash flow
As a business owner who has ambitious growth plans, ensuring that you have a healthy cash flow is crucial . An advantage of debt factoring is it enables businesses to improve their cash flow, use the finance they’ve acquired to reinvest in the business itself.
Expand your business quickly
If your business is taking on new clients or projects, it may need to expand rapidly by recruiting new staff to increase capacity. Debt factoring can enable business owners to boost their working capital, which can give your business the resources it needs to work with incoming clients.
Business is protected from bad debts
Another advantage of debt factoring for business owners is it takes the bad debts your business may incur out of your hands. It’s worth choosing non-recourse factoring where you’ll have to pay higher factoring fees, but it’ll protect your business from any losses if the debtor fails to pay.
Easier to qualify
One of the key advantages of debt factoring is that it’s often easier to qualify for than traditional loans. Factoring companies place more emphasis on the creditworthiness of your customers rather than your business’s credit history. As long as your clients have a good payment history, you may be able to qualify for factoring, even if your own business has limited credit or assets. This makes debt factoring an appealing option for startups or small businesses that are unable to secure loans from banks or other financial institutions.
Disadvantages of debt factoring
Puts your business temporarily into debt
One of the disadvantages of debt factoring is you’ll have to deal with short-term debt. It’s important that you pay off the debt as quickly as possible to avoid getting into bad debt with invoices being unpaid or paid late by clients. Doing a simple credit check with your clients can help prevent future payment problems your business may face.
Reduce overall profit business makes
For businesses, using debt factoring means that while you’ll have an improved cash flow, it can reduce the overall profitability of your business. The debt factoring company charges a percentage of the invoice value, which can vary depending on how small or big the contract is.
The costs associated with debt factoring vary depending on several factors, including the factoring company, the volume of invoices and the payment terms. Typically, businesses will pay a factoring fee, which ranges from 1% to 5% of the invoice value. The longer the time it takes for a client to pay, the higher the costs, as some factoring companies apply additional fees based on the length of the overdue period.
Conclusion
Debt factoring can be useful for businesses who need to give their cash flow a quick boost. They can also help business owners make their expansion plans become a reality by having the finance instantly available to them to create new products and services.
White Oak UK’s invoice finance product allows businesses to raise finance by selling unpaid invoices. By selling those invoices, the business owner can receive up to 95% of the value of invoices for 60 to 120 days.
For business owners who are looking to finance their business through invoice financing, speak to our finance expert. They’ll be able to help see if invoice finance is the right type of finance for your business.
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