Factoring solutions offer the seller of a receivable a wider service than just the advance of funds to shorten its cash conversion cycle as the entity buying the receivable will also usually take on the responsibility of collecting the debt.

Factoring can take several forms. For example, a factor may agree, subject to limits, to buy the whole of a seller’s receivables. This is known as whole turn-over factoring. Conversely, a factor may select which invoices he wishes to buy. It can be with or without recourse to the seller and may or may not be notified to the buyer or obligor.

The vast majority of factoring is domestic and individual invoices are often of a low value. Cross-border factoring is possible using the two-factor system. One factor is in the buyer’s country (known as the ‘Import Factor’) and the other in the seller’s country (known as the ‘Export Factor’). The two Factors establish a contractual or correspondent relationship to service the buyer and the seller respectively under which the Import Factor in effect, guarantees the receipt of funds from the importer and remits payment to the Export Factor. Typically, the two factors use an established framework such as the General Rules for International Factoring (GRIF), provided by FCI. Read more about factoring here.

Invoice discounting solutions tend to focus on shortening a seller’s cash conversion cycle, as opposed to encompassing debt management and collection aspects. The degree of disclosure to the debtor under this type of facility varies, ranging from full disclosure to no-disclosure, depending on the level of comfort taken by the purchaser of the receivables over the nature and standing of the seller. In most cases, the greater the control the financing entity/purchaser of the receivables manages to attain over the process, the better the discounting conditions offered.

An invoice discounting facility without disclosure to the debtor will grant the seller of the receivables full confidentiality, and therefore avoid reputational hazards. Most invoice discounting is without recourse to the seller so as to ensure de-recognition of the receivables from the seller’s balance sheet (so-called “true sale”) but recourse is normally retained for commercial dispute e.g. where the buyer refuses to pay because the goods or service are defective. Read more about invoice discounting here.

Rather than waiting 30 – 90 days, an invoice financier can pay for most of the invoice amount up front, and the interest rate is the amount charged for this service. Interest rates are often linked to base rates the bank will pay for borrowing money, such as the LIBOR, as well as a management fee.

At first instance, invoice finance lenders can advance around 90% of the invoice amount value up front, whether that be through invoice discounting or factoring. Once the invoices are paid by the end customer, the borrower will be paid the remaining difference, excluding interest rate and management fees. Even if the company has existing finance arrangements such as an existing bank loan or overdraft, invoice discounting or factoring may still work for a business.

Normally, a lender will analyse the business prior to implementing a factoring or invoice finance facility. They may audit the financial records of the business and list the approved customers, and the decision is down to legal and contractual implications such as security and existing lenders.

The company should always read the offer letter and look at all (including the following) costs:

• Discount costs
• Service or management fees (including the minimum service fee which is normally derived as a % of the service fee)
• Audit charges
• Re-factoring charges
• Transactional costs
• Notice period for ending service and associated fees
• Annual service costs
• Trust account costs
• Additional costs for services such as credit protection

There are three parties involved directly in invoice finance:

• the funder who advances money against the invoice or receivable
• the business (or customer) who sends out the invoice
• and the debtor who is required to pay for the invoice

A brief explanation: The receivable, associated with the invoice for services or goods acts as an asset and provides the company the legal right to collect money from the debtor. A percentage of funds are then advanced against the value of the invoice.