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Factoring or invoice factoring is a common form of debtor finance. More and more small-to-medium (SME) businesses are turning towards it.
This is simply banks extending credit against money that you’ve been owed. Here, funding can be secured without the need for additional assets.
Unfortunately, it may be difficult for some businesses to qualify. Find out why and how you can get approved.
What is factoring?
Factoring is the purchase of trade debts of a business by a lender (factor) on a continuing basis. Unlike invoice discounting, the debtors here are aware that you’ve taken a factoring facility.
This can help businesses improve their cash flow position. By accessing money already owed to them, they can also create additional working capital.
There is one distinct difference between factoring and invoice discounting. In factoring, the credit control function is outsourced to the lender. This way, you can concentrate on growing your business.
This form of debtor finance is common in manufacturing, recruitment, construction and wholesaling industries.
What are the qualifying criteria?
The qualifying criteria for factoring are similar to that of invoice discounting. If you can meet the following requirement, you’re highly likely to qualify:
- You have a projected annual turnover of $200,000. However, there are lenders that can consider a turnover as low as $50,000 for smaller loans.
- Your products must be sold on normal credit terms.
- There must be a large amount of debtors or suppliers. This way, risk isn’t centralised on one or a couple of debtors.
- Your invoices must not be older than 90 days from the last day of the month of issue.
- Lenders generally reject retailers or contractors that receive stage payments.
- Lenders prefer businesses that have little to no trade disputes.
- Your debtors ledger and credit assessment system are highly efficient.
- If you don’t have history with the bank, you may need to provide security against the loan.
It should also be noted that lenders prefer borrowers with a good credit rating. However, there are exceptions to this especially if you’re a strong business. Smaller specialist lenders may have more flexible requirements but the costs may be higher.
How much can I borrow?
Generally, you can borrow up to 85% of your outstanding invoices with most banks.
However, if you can prove that you’re a strong business with low risk, you may be able to borrow even as high as 90%.
A reputable and strong business can borrow up to 90% even with a bad credit history. You’ll have to apply with a specialist lender though.
If you’re not sure how much you can borrow, you can speak with one of our factoring and business loan specialists. Call us on 1300 889 743 or complete our free online assessment form today.
What can I use to prove my business income?
As with any other business loan, banks will conduct a full assessment of your business income. In most cases, you can prove your business income using:
You can also use projected cash flow statements. Also note that some lenders may not accept your YTD income from MYOB.
What problems do borrowers commonly face?
A common problem borrowers face is not identifying underlying issues with their business. Banks prefer borrowers with a stable and strong business. If any underlying issues are found, the chance for approval decreases significantly.
On the other hand, some borrowers apply for the loan to fix these issues. Depending on the strength of the application, you may still qualify.
Since the loan is essentially unsecured, weaker businesses don’t usually qualify.
Some lenders also prefer if you have history with them. If you’re a new customer, you may be required to have a security property. However, exceptions can be made to strong businesses.
It’s recommended that you prepare yourself before applying. You’re more likely to qualify if you can show that you understand the business quite well.
Please speak with your accountant before applying for any factoring facilities.
Aren’t invoice factoring and invoice discounting the same?
Factoring and invoice discounting are two forms of debtor finance. Aside from a few differences, they are pretty much the same. This is because they essentially provide the same benefits.
Invoice factoring is a disclosed facility where the business has complete credit control. The borrower manages and handles the invoice collection themselves. The debtors don’t know about this arrangement.
However, factoring is an undisclosed facility with no credit control. The lender manages the client’s sales ledger and collection of accounts. The debtors are aware of this arrangement. The lender receives the payments directly.
Larger businesses prefer invoice discounting. This is because they have the resources to manage invoice collection and meet reporting requirements of the lender.
On the other hand, smaller businesses prefer factoring. While the lender handles the invoice collection process, they can concentrate on other business functions.
These are the main differences between the two common debtor finance options in Australia.
How can factoring benefit my business?
Here are a few ways factoring can benefit your business:
- Accelerating the cash flow process.
- Securing finance without the need for any security property.
- If you’re a start-up business, factoring can act as a flexible funding facility.
- The creditworthiness of current and potential debtors can be easily determined. The lender can do this for you.
- If you’re under a non-recourse arrangement, you get access to funding even if the invoices aren’t paid.This is because the lender takes full responsibility of the invoices in this case.
However, apply for debtor finance only if you actually need it. The lenders usually charge a service fee as well as interest on the amount funded. You may also have to pay a management fee in some cases.
Who are involved in the factoring process?
Three parties are directly involved in the factoring process. This includes you (the business), your debtors and the lender (factor).
You’re essentially selling your invoices to the lender at a discount. The lender will then advance you a percentage of the funds. Once all invoices are paid, you’ll receive the balance amount minus the lender’s fees.
If you’re confused about anything or planning to apply, please speak with one of us today. We have mortgage brokers that know which lenders provide factoring facilities. We can also help you make your application stronger so you can qualify for a better deal.
You can speak with one of our mortgage brokers by calling us on 1300 889 743. You can also simply fill in our free online assessment form and one of us will contact you instead.