I put off writing this piece a few years back when I left banking but given that I have now returned to the financial arena now seems as apt a time as any.
For many years factoring, invoice discounting etc were words commonly associated with distressed organisations where banks wanted more control over their exposure. My question is ‘Is this still the case today or has Invoice Finance become the new overdraft?’
To give you a bit of background, the fundamentals of factoring are that rather than a company having to wait for their clients to pay them on agreed terms, IE 30 days, 90 days etc, a financial institute will advance them a percentage of the outstanding invoice upfront so that they can continue to trade normally and then repay the advance when their client pays the outstanding invoices (minus a small fee). The factoring provider would traditionally do credit control, monitor transactions and take control over your book debts, hence why it was seen as a course of action when a bank wanted to have more control over a questionable client. Historically it was perceived that having charge over the book debt and credit control essentially meant that a bank could control the financial aspects of the business and thus manage it out of problems or ensure that it at the very least got its exposure repaid.
However, over the past 5-10 years factoring has become much more of an acceptable facility, and in some cases allow an organisation to raise funds which would, under alternative financial options, be unattainable.
In a global environment where banks are very cautious when lending money and tangible security is in shorter supply (less personal wealth, less equity in properties etc) people are looking for alternatives when raising finance and factoring just might be the right solution.
For example – Take a start-up business, with very little credit rating and accounts to support any lending…it is less likely that a bank would be willing to provide funding against say a well established business with a proven track record. However, as factoring primarily examines the debtors of the business and the product/service being offered it may be that you are much more likely to get funding against your future book debt than say an overdraft. Also, as your business grows and becomes more successful, as factoring is done on a percentage of total sales, the facility can grow as you do where as other more traditional facilities may be limited to the amount of security available.
By this same point, an existing business that wants to grow may have cash-flow issues around expanding and have to turn down future work as it cannot fund the front end…factoring would allow them to commit to that contract and have funds advanced much earlier in the process and thus cope.
Lending against a book debt can also allow things like management buy-outs to take place. Say a parent company wants to sell off a subsidiary, the existing management of said subsidiary can use the outstanding WIP to raise funds to facilitate the purchase…it makes sense to utilise a companies strongest asset!
But there is still a historic stigma attached to this type of facility and perhaps we just need to be re-educated into its use and benefits? I am not saying that it is the be all and end all, but in certain circumstances it can be a favourable solution, comparable in price to more traditional facilities.
What has your experience of factoring been or have you ever considered it to be a suitable solution to your companies financial needs?