What is factoring?

You raise an invoice to your customer and submit it to the factor, which runs credit checks on the debtor. The factor pays you an advance, often most of the invoice value, quickly. It then collects payment from your customer on the due date and remits the remaining balance to you, minus its fees and any reserve.

Unlike a term loan, the facility is tied to the value and quality of your invoices rather than your business assets or past profits, so it can provide working capital when traditional lending is constrained. You can factor individual invoices as needed, known as spot factoring, or run an ongoing facility over your whole debtor book.

With recourse factoring, if the debtor fails to pay you may have to buy back the invoice or reimburse the factor. That keeps the credit risk with you, but it is typically cheaper. Non-recourse factoring means the factor accepts the risk of the debtor's insolvency; it usually costs more and comes with stricter debtor criteria, but it protects you if a customer goes bust.

The other distinction is disclosed versus undisclosed. In disclosed, or full-service, factoring the factor handles collections and debtor communications, so your customers know. In undisclosed factoring, usually called confidential invoice discounting, customers are not told, you keep collecting, and the lender often requires stronger covenants and tighter reporting.

Pricing has several parts: a discount fee charged as a percentage of invoice value, an advance rate, a reserve held until the customer pays, ongoing service fees for admin and debtor management, a set-up fee, exit fees if you leave early, and a premium for non-recourse cover. Actual pricing depends on debtor creditworthiness and the contract, so ask for a full fee schedule and a sample calculation.

Factors look at the quality and concentration of your debtors, payment history, your accounting controls and PPSR searches for existing security interests. Before signing, check the recourse clause, the customer notification wording, dispute handling, termination rights and how the assignment of debts is registered on the PPSR, and ask your accountant whether the arrangement sits on or off your balance sheet.