Sources of Finance - Debt Factoring

Factoring is one of many potential sources of finance:

Long-term:

• Finances the whole business over many years

  • Share capital

  • Retained profits

  • Venture capital

  • Mortgages

  • Long-term bank loans

Medium-term:

• Finances major projects or assets with a long life:

  • Bank loans

  • Leasing

  • Hire purchase

  • Government grants

Short-term:

• Finances day-to-day trading of the business

  • Bank Overdraft

  • Trade creditors

  • Factoring

What is Factoring:

• Factoring is a way a business can raise cash by selling its sales invoices to a third party (a factoring company) at a discount

An example of factoring:

• A business makes sales of £100,000 per month. Its customers are given 60 days to pay their invoices. On average, the business has around £200,000 owed to it by customers at any one time. The business needs to raise cash to improve its liquidity

What can the business do about these invoices?

Two options:

1. Wait for customers to pay their invoices (e.g 60 days)

2. Sell these invoices to a factoring company for cash (at a discount)

   • E.g invoices worth £200,000 are sold to the factoring company

     • The business gets 90% in cash= £180,000

     • The factoring company collects and keeps the £200,000

Benefits and Drawbacks of Factoring:

Benefits:

• Receivables (amounts owed by customers) are turned into cash quickly

• Businesses can focus on selling rather than collecting debts

Drawbacks:

• Quite a high cost (discount offered to the factoring company)

• Customers may feel their relationship with the business has changed