I have a business and it seems my invoices are going astray as no one seems to really want to pay them! It's causing quite a bit of cash flow problems so I have looked at factoring as a possible solution. Any thoughts on its suitability?

Factoring is very much a sign of the times unfortunately, but it is only one form of business finance and you should consider all other options before making a decision. It’s often a case in any downturn that the companies at the top squeeze the companies at the bottom and rely on that good old irresponsible phrase: ' well that's just business'.

It's a bit ironic that businesses spend time focussing on building up assets yet they go bust because banks foreclose on them when they cannot afford to meet their monthly bills. That's where the saying asset rich income (cash flow) poor comes from.

Some economists believe there is no doubt we are either on the verge of a double dip in our economy, or as I believe, a square root sign. There is little that can point to the growth in the economy we have previously experienced, so business will be tight for companies over the next two to three years as we bumble along the top of that square root sign.

Factoring works by raising money for your business by selling off your unpaid invoices to a factoring company hereafter called a factor. Let’s say you are owed £30,000 in unpaid invoices. You approach a factor company who buy the invoices from you. They now chase the company who owes you the money whilst you carry on running your business with your cash flow intact.

The factor company charges its fees/commissions for the appropriate risk it is taking and you are credited with the remainder.

There are two main types of factoring called 'non recourse' and you guessed it, 'recourse'.

Recourse factoring involves you selling off your invoices, but if the company you have invoiced doesn't pay up, the factor has recourse on you. Non recourse does not allow the factor to come back on you and they carry the risk. Because of that risk, non recourse factoring is most appealing to businesses but carries higher fees/commissions than recourse factoring.

The factor company does have the right to aggressively approach the company you have invoiced, especially if they do not pay up and you should bear that in mind before you appoint a factor company.

You can also simply borrow against any unpaid invoices. This is called invoice discounting. With invoice discounting you are simply paying interest on what you have borrowed and the company you have invoiced will never know you have borrowed against the debt if you opt for confidential invoice discounting. This is a more subtle way to manage cash flow and maintain relationships, although it could be argued that if a company has not paid your bill the relationship is over in any event.

Consider also that news soon gets around if a company is in cash flow difficulty. If you are using a factor company they will approach the company who have not paid your invoice and that will soon make its way into the business community, and may send signals that your business is in difficulty, and subsequently damage your ability to get credit with suppliers and the like. You can see why invoice discounting has its advantages.

Another downside of factoring is the cost, as the associated costs to pay the factor will impact your margins and bottom line but that's your call against the possibility you might not get paid at all.

However to eradicate the risk of bad debt, to wash yourself clean of an organisation and move on, factoring has its upsides.

A factor company will give you a price on the costs of the factoring and you will need to ascertain those before you set a factoring agreement in place, because if you are doing business with companies who are classed as a bad debt, the costs will be greater.

If you would like a fact sheet on factoring or a quote call Peter on 0845 230 9876, e-mail info@wwfp.net

Peter McGahan is an Independent Financial Adviser and the Managing Director of Worldwide Financial Planning Ltd who are authorised and regulated by the Financial Services Authority. 'The FSA does not regulate Credit Cards, Will Writing and some forms of mortgage and Inheritance Tax Planning.'

Information given is for general guidance only, and specific advice should be taken before acting on any suggestions made.
The above represents the personal opinions of Peter McGahan.
All information is based on our understanding of current tax practices, which are subject to change.
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