The crucial factor

By LINDA WHITNEY FOR MAILONLINE
Updated:

 

WHEN slow cashflow or an unforthcoming bank is a problem for your small business, a factor can be the answer. But choosing the right one can be crucial.

Factors lend you money against your outstanding invoices, typically offering between 80% to 85% of the money within a couple of days, and then chase up the rest of the bill for you.

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Factoring (or invoice discounting, which is much the same, but you chase the bills yourself) can be a good way to raise funds or make up for slow payers. Also, unlike banks - factors don't expect you to pledge your house or other assets before you get any money, though they generally expect personal guarantees from directors.

It sounds simple enough, but be careful. Your small firm could find itself in trouble if you don't choose the right factoring deal, understand the contracts and the fees you are letting yourself in for.

And many banks own factoring firms which they may be all too keen to introduce you to. Don't feel obliged to deal with them just because your bank manager suggests it.

If you fancy factoring you have to negotiate a deal with a factoring firm, so it pays to understand a few of the issues at stake before you start. Wendy Trollope, co-author of the Guide To Factoring And Invoice Discounting, says: 'Don't just look at the basic fees factors charge. Ask about any others and get a full explanation of the contract.'

With fees there's a fixed monthly administration charge based on a negotiated percentage of the expected annual value of your invoices, normally 0.75%-2.5%. You also pay interest on any money you draw down from the factor, for which you usually pay about 2% to 4% above bank base rates.

But check for other less obvious fees and contract terms such as:
• Extra charges each time the factor checks the credit status of new customers for you.
• 'Refactoring' charges for debts that go past their due date - sometimes up to 1% of the invoice value.
• Renewal fees on the anniversary of your factoring agreement.
• 'Spread restrictions' - some factoring contracts say that if you do more than a specified percentage of business with one customer, the factor will not forward money against invoices above that limit.
• Credit insurance - administration fees may include this, but check how much of the debt is covered, it may not be 100%. And when will you get the payout?
• Minimum monthly charges regardless of your turnover.
• Charges for payments via the CHAPS banking system (faster than the more usual BACS system). Some factors pass these bank charges on to you.
• Restrictions on what you can draw down. The factor may say it is 80% of invoice value, but they may not include any invoices in dispute, or awaiting credit notes, so you get 80% of the reduced amount.

Gary Edwards, a partner in recruitment company Call Centre Staff UK of Altrincham, Cheshire, found that their factor's rules were getting in the way of business growth. 'We started using a medium-sized factor in April 2000, and everything went well for six to eight months. But they imposed credit limits on our clients that started to become too tight,' says Mr Edwards.

'One very big company had a limit of £15,000 in outstanding invoices, so when their level of debt went above that, the factor would not let us draw down any more money against it. We were expanding fast and it was hindering our growth.' The firm decided it had to swop factors and found Cash Friday, which provides factoring and payroll services specifically tailored to recruitment companies.

'At 6% of sales a week, their service costs a bit more than the previous factor, but they pay the whole temp bill on Fridays, chase all the debts and manage the payroll as well as banking our profits,' says Mr Edwards. 'It means the staff member who used to handle all that admin can now work on developing new business.' He says: 'I'd recommend any small firm seeking a factor to look at the whole package they offer, not just the basic fees, and think about how it will suit you not just now but later, too.'

The factor will be checking you out, too. Your projected turnover must be at least £100,000, and with most companies it must be at least £150,000 to £250,000. Small firms may be better with a factor that specialises in small businesses, such as Close Invoice Finance. The biggest factors may not always understand your problems so well.

Factors also look for a spread of debtors where no one debtor is responsible for more than 30% to 50% of your outstandings and an average invoice value of more than £100 (less in some cases).

If they suspect you are looking to factoring to save an ailing business they will turn you down. And be aware that although your cash flow will get a boost, an overdraft - if you can get it - could be less expensive.

• Information and lists of factors from the Factors and Discounters Association on 0208 332 9955, or Factors and the DTI at DTI

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