You name it, the next firm calls it something different!
In essence they all produce the same result. So, let’s sum up what it is all about.
XYZ Ltd sell widgets. They get an order, make the widgets then sell them on 30 day terms. In reality the buyer doesn’t actually pay their invoice until day 60.
XYZ pay for the raw materials when they receive an order. This means they pay out cash on day 1 and get their cash in on day 60.
So, how do they pay the bills, salaries, rent and everything else in the interim?
The bank only have a finite limit to the level of overdraft they will provide, so when this is reached what do XYZ Ltd do?
Invoice Finance / Factoring
QRS Invoice Finance Ltd will provide a facility to XYZ Ltd. QRS Invoice Finance do a credit search on the debtor. XYZ send their invoice to QRS who pay 80% of that invoice value on day 1. The balance is paid to XYZ when the invoice is settled.
XYZ change the payment details on their invoice, no long quoting their own bank account but now quoting that of QRS Invoice Finance.
This means that XYZ Ltd is now using it’s debtor book to fund it’s cash flow. Their business is ‘self sufficient’ and because finance is advanced against each invoice there is no finite limit to the facility. Meaning it will increases as their business grows.
QRS Invoice Finance charge a fee and interest for the money they have lent.
All in all a very good solution to the cash flow problem.
Difference Between Invoice Finance & Factoring
In essence they do the same thing. The main difference is this –
Invoice Finance –
This is exactly as the example above. In this case XYZ Ltd would chase their customer for payment. The Invoice Finance company would need to be confident that XYZ have the right controls in place to manage the invoice collection.
Exactly the same, apart from in this case the Invoice Finance (or Factoring) company chase for payment of the invoice. Consider this to be a complete outsourcing of your credit control and invoice payments.
Factoring gives the lender more confidence as they are in control of things, they can chase quicker and have a little more weight to through around in the event of late payment.
Why The Choice?
Put simply. Some companies want to retain control, or not divulge that they are using an Invoice Finance/ Factoring facility. This is often referred to as a ‘confidential’ facility.
I hope this gives some indication as to how this type of finance works. You can download the diagram example here – Resource – Invoice Finance which shows how it can improve cash flow.
If you have any questions please contact us here, or add your comments above.