This is the fourth in a blog series I started a couple of weeks ago, talking all about invoice finance.
As I mentioned last week, there are a variety of options available when it comes to invoice finance. They all work in different ways and have different qualifying criteria, but essentially the main types of invoice finance are as follows:
- Spot factoring
- Invoice discounting
- Selective invoice discounting
Over the next few weeks I’m looking at each of the options in more detail, continuing this week with spot factoring.
This refers to a form of factoring where a business “sells” a specific invoice to a factoring company and borrows a percentage of the value of the invoice, with the cash raised then being available to inject into the business.
It is fundamentally the same as full factoring as described last week, with one crucial difference.
With a full factoring facility, the security for the facility is all the invoices raised by the business. It is an ongoing, rolling contract where funds are raised against the entire sales ledger.
Spot factoring, also known as single invoice factoring, differs in that there is no need to factor all the invoices within the sales ledger. Instead, spot factoring allows you to raise funds against individual invoices. In other words, you can choose which invoices to raise funds against, invoice-by-invoice.
In layman’s terms, full factoring is like having a monthly mobile phone contract, whereas spot factoring is more akin to using a mobile phone on a “pay-as-you-go” basis.
Again, like full factoring, spot factoring enables you to raise up to 70%-95% of the value of the invoice, with funds often being available within 24 hours.
As a result, it is a fast and effective way to access funding. Spot factoring is particularly suitable for businesses who raise invoices which tend to be of high value or where a product or service is provided on extended credit terms. This being the case it can cause a temporary cash flow shortfall.
Spot factoring could be the solution
The process for setting up spot factoring is relatively quick and straightforward.
- Having selected a factoring company, the business sets up the new spot factoring facility and agrees the terms of the facility on offer including the percentage available against each invoice as well as agreeing the rates and charges in relation to the funding.
- The business then chooses a specific invoice to raise funds against. This will typically be a relatively large invoice of upwards of say £5,000. The invoice is then assigned to the spot financier.
- As part of their due diligence, the funder will verify the invoice to make sure it is not fraudulent and then advance the agreed percentage to the borrower typically between 70% and 95% of the value of the invoice being factored.
- The charges for spot factoring are very similar to a full factoring facility, being a discount fee and a service charge. I highlighted all the costs of factoring in last weeks blog.
So, what are the advantages and disadvantages of a spot factoring facility?
- No lengthy contracts – spot factoring means you can access funds without the need to enter into a long contract. That means no minimum or maximum term, with fees charged on a pay-as-you-go basis
- Quick access to funds – once the facility has been agreed, funds can be released quickly, often within 24 hours.
- You have the flexibility to access funds to suit your requirements. You choose which invoices to factor and when, entirely dependent on your cash flow requirements.
- No other security is required – many spot factoring providers will not ask for any security other than the invoice itself.
- You don’t need an impeccable credit rating – the factoring company providing the funding is more interested in the creditworthiness of your customer, so having an adverse credit file isn’t “the end of the world”.
- The spot factoring company will collect the debt from your customer, so you don’t have to.
- Because you are not using your entire sales ledger, but rather factoring on an invoice-by-invoice basis, that means you retain the overall credit control function within the business.
- No personal guarantees required or a debenture over your company.
- It is also worth mentioning that spot factoring companies are often prepared to work with the construction industry. This is often not the case with full factoring facilities.
- Although spot factoring is typically a fast process, the initial setting up of the facility can take time. This is because the funder will want to check the creditworthiness of your customers and carry out due diligence to make sure the invoice is not fraudulent. So, whilst the actual release of funds can be quick, getting to that point can take time, so plan well ahead of schedule rather than leaving it to the last minute when funds are needed urgently.
- Loss of control – bear in mind the spot factoring company assumes responsibility for collection of the debt, meaning they will be the ones contacting your customers for payment. This does not always go down well, so as I mentioned in last week’s blog when I talked about full factoring, speak to your clients ahead of time and give them a “heads up” by letting them know what you’re doing.
- The cost-per-pound borrowed can be relatively high when compared with more long-term factoring facilities secured on the whole of the sales ledger.
In summary, spot factoring provides you with a quick and reliable way to raise cash on an invoice-by-invoice basis to inject funds into a business and is particularly suitable for short term cash flow requirements where funds are often needed quickly.
Spot factoring can also be an ideal funding solution for businesses that operate in either the business-to-business (B2B) or business-to-government (B2G) sectors, and also for businesses who carry out relatively large-scale projects, have just a few major customers or who don’t require a constant source of working capital.
Having looked at spot factoring this week, next week I’ll examine invoice discounting and its “pros and cons”.
In the meantime, if you are currently experiencing cash flow problems within your business and want to talk to an expert, then email us at firstname.lastname@example.org or give us a call on 020 8949 2122 and let’s see how we can help.