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What Makes a Business Suitable for Invoice Factoring?

Invoice factoring is a popular means of realizing the cash tied up in a business's invoices. However, as with many other aspects of the financial services industry, there are few rigid rules although there are a number of guidelines that should indicate to you whether or not your business is suitable for factoring.

In using the term 'factoring' we shall include here invoice discounting as well as invoice factoring, since the two are linked, although the qualifying factors are not the same for each. It should be noted that, as referred to above, this guidance is just that - guidance - and can vary between lenders or factors. Nevertheless, the general guidance is accurate and most companies offering this service will apply them as they are presented below.

The factors that make a business suitable for factoring are both financial and statistically related to their customers. To explain that it is best simply to offer these factors and then discuss them. So, the major aspects of a business that factors will take into account when determine its suitability for invoice finance are:

  • Its annual turnover: at least £50,000 for invoice factoring and £500,000 for invoice discounting. It might be possible for factoring to be offered on smaller turnovers for small businesses or for new businesses starting up with no annual figure as yet to offer.

  • The business must have a good number of customers - described as 'more than a few'.

  • No individual customer should be responsible for more than one third of the annual turnover.

  • The customers of the business must agree to normal credit terms - generally 30 days.

  • Standard payment terms for the specific industry the business supplies should be observed.

Business Turnover

Taking factor A first, the turnover of a business is important to lenders because if a business is too small it might not be able to continue to maintain the agreement. Invoice discounting demands a much higher annual turnover because the company itself is taking responsibility for credit control. While it is a fact that too small a business may be involved in larger numbers of small invoices, it might also be unable to repay the advance provided if customers fail to pay.

Where a business undertakes credit control itself, as in invoice discounting, then that would likely be less effective  than the collection techniques used by the factor, and so more invoices could go unpaid. The higher turnover leaves more scope for a business to afford to repay the cash already offered on unpaid invoices. 

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More Than a Few Customers

The more customers a business has then the more likely it is that the business will survive one or two failing to pay their invoices. The fewer the number of customers, then the greater the impact on the business of customers failing. The loss of one or two customers from a total of 100 has less impact on a business than from a total of 10.

Lenders must protect themselves from the possibility of a business to which they have advanced a large sum of cash themselves failing due to the failure of one or two of their customers. Statistics have shown the greater the number of customers a business has, the less the effect will be of some of these customers going into receivership or becoming bankrupt.

No Customer Being Responsible for More than One Third of Turnover

Items B and C are connected: if a customer responsible for such a large proportion of invoice value goes bankrupt or fails to pay in any other way, then the implications to the business could be very serious. No lender or factor will want to risk cash against the health of one specific customer whose demise could also mean the failure of the business owing them money. 

Standard Payment and Credit Terms

Factors D and E are being considered together because the factor needs all customers to be treated the same. They do not have the time to consider numbers of individual customer agreements when many of their processes such as reminders and initial demand notices may be automated.

There is no room for individual agreements and arrangements in modern financial services, although this is not an issue with invoice discounting, where you are responsible for collecting your own invoices.  However, even with discounting, many lenders will insist on the same terms for all forms of invoice finance. The issue is ultimately 'ability to pay', and your ability to pay gets less with each non-standard arrangement that might be difficult to enforce.

The above terms are fairly general across the industry, and you are unlikely to find any factor agreeing to invoice factoring should any be breached. There are also some factors that would immediately disqualify a business from invoice factoring, irrespective of them conforming to the above.  Among these are:

  • Selling to the public:  only B2B selling can qualify for invoice finance.

  • A business has excessive recorded disputes and problems with its customers.

  • The company's turnover arises from large numbers of small invoices that are costly to manage.

  • The company has complicated arrangements with customers regard warranties and business contracts.

Your company must also enjoy good standing and be totally trustworthy. These factors are designed to protect the lender's investment, and ensure as far as is reasonably practicable that investing in your company is an acceptable risk.

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