Monday 9th Sep 2019
Invoice factoring is a type of asset-based finance, designed to help small- to medium-sized businesses maintain positive cash flow. Under a normal invoice factoring arrangement, you essentially sell unpaid invoices to a lender. Your lender will then release a percentage of the invoice total upfront, and then chase payment on your behalf.
Because the needs of SMEs tend to vary according to growth stage and industry, lenders often offer several different types of invoice factoring, including:
- Recourse factoring
- Non-recourse factoring
- Whole-turnover factoring
- Selective factoring
- Spot factoring
To help you work out which of these options will suit your business, this article will walk you through the five main types of invoice factoring. Reading on, you will also find information on the types of invoice financing that are normally used by a range of different business types, from contractors to start-ups and everything in between.
Recourse factoring is a type of invoice factoring facility where you take responsibility for any unrecoverable funds. Imagine that you factor (or sell) an invoice worth £5,000 but your client defaults on the debt, and your factor cannot collect the money owed. Under a recourse factoring arrangement, you would then need to repay the £5,000 loan so that your factor wasn’t out of pocket.
Recourse factoring accounts for approximately 90% of all invoice factoring arrangements, because it allows factors to lend money without shouldering the risk of bad debt. Sole traders, contractors and start-ups tend to be offered recourse factoring arrangements too, but it’s worth remembering that recourse factoring facilities can still be immensely beneficial in the sense that they free up read cash for expansion, and allow you to take full advantage of your factor’s in-house credit control systems.
Under a non-recourse factoring arrangement, the factor assumes full responsibility for any bad debt, which means you won’t have to repay money leveraged against an unrecoverable invoice.
These agreements tend to be rarer, and the risks associated with this kind of lending mean that factors normally charge more for non-recourse factoring.
Using a whole turnover facility, you will factor every invoice as soon as you issue it; guaranteeing a steady flow of ready cash, and providing you with the resources needed to grow your business. Whole factoring agreements tend to be used by sole-traders, contractors, start-ups and SMEs that value positive cash flow, and don’t have their own credit control processes.
Selective factoring allows you to choose which invoices you finance. This gives you greater control over the credit collection process, and allows you to avoid unnecessary fees if you have clients that can be trusted to make good on their invoices within the stated payment window. However, selective factoring does require some internal credit control, so this type of factoring tends to be less suitable for sole-traders and contractors.
Spot factoring facilities allow you to finance a single invoice. These facilities are normally used in emergency situations, and tend to be quite expensive.
If you’d like to learn more about the different types of invoice factoring,you can find more information on our dedicated page here.