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Debt factoring: Advantages and disadvantages

Posted by Todd Davison on Aug 26, 2021 1:29:21 PM

You can be doing lots of business, but still be relatively cash poor. The late payment of invoices makes cash flow a real issue for SMEs who, having done the work and paid for supplies, are left to wait to receive the revenues for the labour.

In a recent survey conducted by business banking firm Tide, it was estimated that UK SMEs are chasing more than £50bn worth of late payments.

The research unveiled that the typical UK SME is chasing five outstanding invoices at any one time, which amounts to an average of £8,500 being owed, and 1.5 hours per day on admin. 

It’s not only the lack of income that’s taking its toll on SMEs, but also the unprofitable admin of having to chase late invoices. So, what’s the solution?

What is debt factoring?

Debt factoring is a type of financing solution where a company sells its outstanding invoices to a third party at a discounted rate. Its popularity with SMEs has soared in recent years – perhaps no surprise given the issue with late payments – who are attracted to the instant access to capital.

However, before you opt to sell your outstanding invoices, you need to weigh up the advantages and disadvantages of debt factoring to understand if it’s right for your business. Let’s take you through them…

Advantages of debt factoring

The most obvious advantage of debt factoring is that it improves cash flow, with the finance provider injecting capital straight into the business – the amount is determined by the value of the invoices.

This capital can be put towards operational costs or reinvested into the business with a view to grow it. For many businesses, it is late payments which are inhibiting their growth plans – debt factoring allows them to take on more work, with cash to pay for the necessary supplies and labour.

It also frees up staff, who are spending hours of the day chasing outstanding invoices, to use their time more productively. Once the finance provider takes ownership of the invoices, it is their responsibility to chase late payments.

Disadvantages of debt factoring

It needs to be stressed that there are fees included with any debt factoring arrangement, which are usually 1-3% of the overall invoice value. If you’re selling a number of invoices, this can really add up, and ultimately it means your profits are diminished compared to if you were receiving the payment directly from the customer. 

Debt factoring also means that your clients will know that you’re using a third party, which might not sit well with all businesses. With the finance provider in charge of the firm’s sales ledger, they might not be as lenient as you are with your clients, which can be detrimental to the customer relationship.

Finally, the debt factoring company may ask for a personal guarantee, as a matter of good faith, in order to set up the facility. Of course, if you operate your debt factoring facility correctly there should be no need to call on your guarantee, but sometimes things happen outside your control. For example, if a major debtor went bust, you could be called upon to repay the funding against that debtor.

However, you can take our personal guarantee insurance when securing finance for your company, which will cover up to 80% of your risk. 

Personal guarantee insurance ensures you’re personally protected as you plan the future funding and growth of your business. For more information on what personal guarantee insurance entails, speak to one of Purbeck’s specialists today on 0208 004 7252.

Topics: #pgi, #personalguarantee, #personalguaranteeinsurance

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