How Does Debt Factoring Improve Cash Flow?
Updated in June 2023
With debt factoring, it’s possible to fund working capital and expand your business. You’ll be able to make investments and obtain early payment discounts, and the more invoices you have, the more funding becomes available. This cash flow-enhancing solution offers flexibility and eliminates time-consuming administrative tasks — depending on what debt factoring type you choose.
So what is debt factoring, and what industries benefit from this service the most?
What is debt factoring?
Debt factoring, also known as invoice factoring, is a complete funding solution. It’s a type of accounts receivable finance that allows businesses to get paid faster in return for the products and services they supply. This enables businesses to sell any outstanding invoices they have to a third-party commercial finance company.
Many businesses struggle to grow and develop due to financial constraints caused by late payments and prolonged settlement deadlines. Debt factoring companies entirely mitigate this issue by filling in the payment gap. Rather than waiting 57+ days on average to be paid, you receive an immediate cash injection using your current invoices.
Simply submit the invoice to a debt factoring company up front, and they will buy the invoices off of you. Then, they’ll immediately provide a cash advance. Many providers fund around 80% of the value of your invoices. Others such as Sonovate fund of up to 100%.
The factoring company will then take full responsibility for:
- Chasing unpaid invoices.
- Collecting payment invoices from your clients.
- Credit control.
Types of Debt Factoring
Debt factoring is very popular amongst successful organisations. In fact, invoice finance supports UK businesses with £275 billion worth of sales annually, according to UK Finance’s 2022 report. But out of the various debt factoring options, which do you choose?
There are four main types of debt factoring you can consider for your business. Let’s break these down.
Confidential factoring supports reputation management while receiving immediate cash advances on outstanding invoices. As a more private approach to debt factoring, clients remain unaware that you utilise the services of a debt factoring company. When deciding on an invoice factoring facility, ensure they’re reputable and established to prevent confidentiality issues from arising in the future. It’s important to note: qualifying for confidential invoice factoring typically requires high turnover rates in your business.
Disclosed factoring is very similar to confidential factoring, but clients directly pay the invoice finance company. With a disclosed invoice discounting arrangement, submitted invoices contain a note that states the invoice payment has been assigned to a debt factoring provider to make clients aware. Disclosed factoring fees tend to cost more than confidential factoring services as more administration is required to execute the process.
CHOCC factoring is a type of invoice factoring where you still chase payment for the invoices you’ve factored, rather than the factoring company doing so. CHOCC is an acronym meaning ‘Client Handles Own Credit Control
This common form of debt factoring requires your business to repurchase any outstanding invoices from your invoice financing company that they can’t collect payment for. With recourse factoring, your business remains responsible for your client’s unpaid invoice. That’s why this is a cheaper option than non-recourse factoring. Some vendors offer bad-debt protection to mitigate your risks. For example, Sonovate offers 95% bad debt protection as standard.
Non-recourse factoring means that you’re no longer responsible for your client’s payment after an invoice financing facility buys it off of you. So if a client refuses payment, you have no obligation to take the loss from your debt factoring provider — so long as these circumstances are covered in the recourse agreement.
How Debt Factoring Works
Debt factoring supports businesses with quick access to funds owed within 24 hours of the request. This service has become very popular amongst small businesses and medium-sized enterprises (SMEs) because of its ability to provide them with immediate access to cash. Invoice financing streamlines the whole payment process and bypasses the long waiting times generally attached to invoice payments.
The Steps Involved in Debt Factoring
Debt factoring isn’t a complicated process. In fact, it’s uncannily similar to a flight booking process. We’ve broken it down into five key steps.
- Invoice your clients: Administer invoices to your customers or clients after doing business with them.
- Submit all invoices: Submit every outstanding invoice to the debt factoring provider for processing.
- Deposit your cash: The debt factoring company will buy that invoice at a discounted rate and provide an immediate cash advance of up to 100% of the invoice value.
- Client payment: The customer/client pays the invoice when it’s due to the debt factoring company.
- Collect your money: The invoice factoring company then pays you the remainder of the invoice, minus a small factoring fee.
Advantages of Debt Factoring
Improved Cash Flow
With the perks surrounding debt factoring, its ability to improve cash flow is by far the greatest benefit. Cash flow is crucial to the survival of a business, regardless of industry. It’s the key to growth but also day-to-day operations.
Allowing a business to immediately receive the cash value of their invoices enables them to instantly inject the cash back into the business and function. Debt factoring increases capital for trade, which is extremely important for company growth, and waiting times no longer prevent companies from making investments for business growth.
With invoice factoring services, your business would be able to:
- Take on more projects.
- Pay business expenses.
- Shorten cash flow cycle.
- Improve working capital.
- Employ more staff.
- Gain access to equipment and resources.
- Make quick purchasing decisions.
The vicious cycle for many businesses with unpaid invoices is that they’re also trying to manage their cash flow too. Therefore, paying a seller earlier is not in their best interest – causing a gap in payment time. With this in mind, debt factoring caters to both parties as they:
- Allow late-paying customers.
- Manage extended invoice payment terms.
- Chase payments without the risk of ruining client relationships.
Meanwhile, your business is able to focus on sustaining growth with immediate access to capital, so you can quickly reinvest back into the business.
Without any alternative funding sources, most businesses bridge the cash flow gap by using personal savings and hefty bank loans in an attempt to stay afloat. That’s why accounts receivable is one of the most important assets a company can own. However, without access to the cash at hand, growth will stagnate.
Debt factoring has also become popular for businesses with poor credit as a quick alternative to business funding. Rather than a one-off loan, debt factoring gives you consistent access to cash flow. The more invoices raised, the more access to cash flow you have. To sustain success as a business, it’s important to maintain a strong and steady cash flow, which is why debt factoring is a great ongoing support for keeping your business afloat.
As with any beneficial concept, there are a few drawbacks to consider before investing. Here are the key points to keep in mind:
Trust in a Third-Party
Before committing to a debt factoring agreement, it’s essential to ensure that they’re an established, well-reviewed and dependable facility. If your business provides third-party services, such as a recruitment agency, you’ll understand the importance of establishing trust with your clients.
To avoid running into issues later down the line, make use of your right as a client to ask in-depth questions, trial its services and assess the quality of its customer support. Continue to search the market until you find the right debt factoring company that’s communicative and flexible in meeting your business needs.
How Sonovate Supports Your Business
Sonovate supports businesses of all sizes with an advanced platform that provides an all-in-one solution. You have the choice to employ an invoice factoring system with back-office support or take a funding-only option to fit your flow. We offer transparent pricing so you always know where you stand.
Sonovate will collect payments on behalf of your company, along with back-office services to help manage the running of your different contractors — if you meet our fully branded VAT requirements. Find out how we compare to traditional invoice finance companies to get the most out of your cash.
Get a free quote to discover just how much finance you can free up with immediate action to continue building your business towards a brighter future.