In these times of difficult finance one option for businesses is to factor the book debt they carry on their sales (accounts receivable) ledger. It is a perfectly legitimate way in which to raise cash, and it can be appropriate to businesses at the time and under certain circumstances; it is not necessarily the best.

Benefits

• One-off injection of cash from the factoring agent.

• Reasonably quick ongoing partial advance payments on your sales invoices.

Downsides

• It is not a fixed loan – it is constantly “refreshed” with ongoing invoices, so it is never being repaid, unless a plan is put in place to do so.

• Charges tend to be based on the book debt outstanding, so if the business is growing its sales, the charges continue to grow too, and can quickly bear no relation to the original “advance”.

• It can be very hard for businesses to wean themselves off factoring once they have started, simply because most businesses come to depend on the advance credit supplied.

• I have come across many businesses that have really regretted going down a factoring route because of the expensive charges.

• It is not a guarantee for payment – businesses usually still have to ensure payment comes in, carrying an unchanged risk of facing bad debt.

How it works

• A good analogy is the credit card.

• All works fine as long as the account is cleared each month.

• But is the balance is not cleared, interest starts to be applied and is generally based on the oldest transactions, which of course will bear more interest.

• Interest charged is generally at higher rates than offered by more conventional borrowing sources.

I have seen many cases of severe difficulty that have arisen as a result of running up large debt on credit cards.

Recommendations

• Aim to obtain more traditional sources of finance first – they tend to be much cheaper.

• Plan to use it for a fixed period only.

• Have a robust plan to wean the business off it, and within a reasonably short period of time.