Twenty five years ago, little was known about alternative business finance. Companies needing funding went to their banks and negotiated an overdraft facility. The recession at the end of the 80's and the banks' tightening of credit acted as a spring board for factoring. Unfortunately, this generated an image of being the lender of last resort which has taken some time to shake off and, in fact, there is still a general lack of knowledge about the scope of factoring and its benefits - partly, perhaps, because the terminology can be confusing. So before we look at the subject in detail, let's set the record straight.

FACTORING means selling your invoice to a Factor who will then be responsible for collecting payment of the invoice from your client. You will receive up to 90% of the value of the invoice immediately and your factoring partner will assume full responsibility for the sales ledger.

INVOICE DISCOUNTING offers the same basic facility as factoring in that it provides immediate working capital by releasing cash that would otherwise have been tied up in unpaid invoices, but without the sales ledger and collections service. In this case, your funding partner advances your business cash against the value of outstanding invoices, but you retain the collections in the usual way.

INVOICE FINANCE, RECEIVABLES FINANCE, SALES FINANCE, DEBTOR FINANCE are all generic terms referring to the range of products that release upfront, the cash value of trade debts. Whether it's factoring or invoice discounting, the basic premise is that the financier provides you with a significant percentage of your debtor book up front, releasing the remainder, less a percentage fee, once the debt has been paid.

ASSET-BASED LENDING is lending against assets on the balance sheet, debts (invoices) are now recognised as one of these assets and therefore funding can be leveraged. Other assets may include stock, plant and machinery and property.

Whichever label is given to the facility, there is always a place for factoring and invoice discounting. These two funding mechanisms have been the catalyst for the innovative and wide-ranging funding vehicles available today and will continue to drive the market forward.

Until recently factoring was considered only appropriate to SMEs and invoice discounting was reserved for medium to large sized, profitable businesses. It's still true that factoring is an excellent alternative for small, young or start-up operations. Further, it often makes sense for SMEs to hand over the management of their sales ledger to a third party in return for immediate cash; which may be more efficient and cost effective than hiring a full time employee. This is also the reason larger firms originally dismissed factoring in favour of invoice discounting: whilst they needed the cash, their in-house teams meant they didn't need the add-on services.

However, with the flexibility of both options their popularity has sky-rocketed, blurring the lines between SME and larger businesses so that both groups have come to utilise the benefits of each.

Beneficial Features include the level of financing being determined by the future potential of a business rather than past performance. Further, both recognise the need for flexibility, allowing funding to grow as the business grows and both are responsive to its changing needs; when compared to the overdraft or loan, factoring and invoice discounting provide open-ended, long-term relationships that don't come with a fixed repayment structure and the finance is tailored to the specific needs of the business rather than an off-the-shelf package.

Users agree that any costs involved are far out-weighed by the benefits. By providing an immediate injection of cash, they can facilitate growth and development, free up working capital and provide an excellent opportunity to negotiate discounts with suppliers or invest in equipment, people and new markets.
With popularity has come competition and a cross-over of services. Previously, only businesses with a turnover in excess of £1m qualified for invoice discounting. Today, provided a business can demonstrate sound management practices and effective collection of its own invoices, any size company can utilise this service.

As expectations of business owners have increased, so providers have had to respond with wider and more diversified product ranges: bigger clients have meant factoring providers have had to become more professional, better organised and capable of bigger deals, which has driven the factoring industry to evolve and include not just invoice discounting in its portfolio, but broader asset-based lending activities as well.

As businesses of all sizes have embraced the concept of using their assets as a means of funding their operations, invoice discounting has overtaken factoring as a preferred funding mechanism. In June, the ABFA indicated that nearly 48,000 companies in the UK were using invoice finance and ABL funding, and that the trend for larger companies to use the products to help fund mergers and acquisitions was on the rise.

As the market continues to mature, providers are developing strong niches where their customers can benefit from greater added value services by outsourcing their receivables. So, whilst there is a strong demand for invoice discounting, there is still a great need for factoring.

Factoring is evolving as a relationship-based service and it is this approach that has helped providers develop their understanding of specific industries that have historically been outside of their remit. Traditionally, factoring has only been suitable for businesses where transactions are clearly defined - like manufacturing and services. But, as providers become more innovative, they are investing the time to understand how to finance more complicated payment structures, like those prevailing in the construction industry.

Whilst new industry sectors are awakening to the benefits of factoring and invoice discounting, the most powerful attribute these options have to offer is still their service driven approach. They offer entrepreneurs access not only to cashflow but also that most valuable commodity, time. So, as invoice discounting overtakes the overdraft as the primary source of mainstream funding for SMEs, factoring will further develop as a value added proposition, seeking new niches and delivering that invaluable element of time back into the schedule of management teams across the UK.


Evette Orams
Director
Hilton-Baird Financial Solutions
www.hiltonbaird.co.uk [1]