The economic downturn has seen invoice finance, and specifically factoring, take its place in the finance mainstream. A continuing lack of traditional credit-based finance, and a decreasing appetite for risk amongst both lenders and borrowers, goes some way to explaining why the Asset Based Finance Association (ABFA) estimated that total advances via invoice finance at the end of last year stood at an impressive £14.1bn.
It is clear that in the current economic climate businesses need a healthy cash flow to successfully navigate their way through the recovery. During this period of ongoing economic uncertainty, where recovery is fragile and growth is nascent, more and more businesses are exploring invoice finance and factoring as a preferred method of keeping their balance sheets healthy.
Each year, Venture Finance speaks to accountancy professionals across the country to create an accurate and up to the minute snapshot of small business finance activity. The company’s 2010 Credit Check found that two out of three accountants now believe UK small or medium-sized enterprises (SMEs) should be made more aware of the benefits of invoice and asset-based lending, and that 53% believe it is the most effective form of financing to support their clients’ growth.
Yet this increase in popularity has also seen a rise in criticism due to the myths and misconceptions surrounding factoring, which prevent many businesses from exploring it as a viable option. So, what are these myths, and what is the truth about factoring?
‘I’m Better Off Taking a Bank Loan’
The traditional world of finance is without doubt significantly more risk-averse, post-recession. As a result, many businesses are being prevented from capitalising on opportunities, or being denied the firm financial foundation they need to stabilise and manage performance levels.
The 2010 Credit Check found that many UK SMEs are facing a ‘working capital time bomb’, with 25% of businesses currently exceeding their working capital and more than a quarter (27%) shrinking and even failing due to a lack of funds.
Certainly, if a company is new, or historical performance has been diluted due to the recession, a bank loan or overdraft is not always a long-term business solution. Factoring is a far more sustainable form of financing as it is success-linked and directly follows sales performance. Therefore, funding automatically adjusts to provide the level of finance that companies need to enable growth. In addition, it offers a more individual and flexible approach, providing greater mobility and access to opportunities than traditional banks that now, more than ever operate a ‘one size fits all’ business model.
‘Factoring is Not Right for My Business’
Factoring is a valuable finance tool for both fledgling businesses and start-ups with a strong business plan, but it is available to any company with an annual turnover above £100,000, including established firms.
Unfortunately, we’re a long way from operating in a business world where customers pay immediately. Factoring can help to keep a business’s balance in the black as companies can plan their finances knowing that they no longer have to wait 30, 60 or even 90 days for payment.
Factoring also gives companies more control over their cash flow and business planning, helping to manage debts. It puts responsibility for chasing up any outstanding invoices in the hands of the factoring firm who appoint a single, knowledgeable and highly-trained point of contact for customers to talk to about repayment.
End customers will often take a call from a factoring firm much more readily – and seriously – than one from an individual supplier. This serves to move payment up the clients’ priority list and ensures that the money owed to a business is paid more quickly. It also allows companies to focus on the day-to day running of a company, knowing that their finances are secure.
‘Factoring is Prohibitively Expensive’
Factoring is more expensive than some credit-based finance but it is also a much broader financial product with many added advantages. Unlike a simple line of credit, a factoring service takes control of a business’s entire sales ledger. Essentially, the company is backed up with a professional credit control facility whilst the best providers often offer one dedicated (and courteous) point of contact.
This then relieves a company’s sales team of the time-intensive responsibility of chasing payments, leaving them free to focus on other business-critical areas.
‘Factoring is Too Risky Right Now’
Quite the reverse is true about the risk of factoring today. In the current economic climate, credit-based funding from more traditional sources, such as banks, is reportedly less readily available than before the recession, and comes with stringent assessments and significant interest rates for those lucky enough to be approved for a loan.
Invoice factoring adopts a more common-sense approach, linking finance more closely to business performance, bringing with it the certainty required to stabilise, grow and even expand. Unlike traditional funding, it cannot be suddenly withdrawn overnight with little reason and scales without the need for renegotiation. It also acts as a lifeline to businesses by helping to protect against debt and provides additional security, as many factoring companies will insist upon running a credit check on potential customers, reducing the risk of both parties becoming entangled with a company that doesn’t have the means to pay.
Similarly, bad debt protection (working alongside a factoring service) can also be hugely beneficial as the provider takes over full responsibility of the debt if the customer becomes unable to pay and will thoroughly and regularly assess debtors. This not only reduces the risk of defaults but also leaves businesses with a stable of high quality clients.
In short, factoring has many practical advantages over traditional credit-based finance and provides extra reassurance and security for companies still feeling the financial strain of recession.
It is clear that the entire industry, including banks, independents and introducers, need to debunk the common misconceptions that surround invoice finance and factoring. It is essential for the health of the UK economy that businesses successfully ride out the recession. To do this, companies must be aware of all the lending options available to them. Only with more adequate funding and increased working capital can companies grow their way out of recession and flourish in the recovery.
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