Factoring gives companies access to the funds they’re owed today before customers actually pay. It’s a standard and common practice for most small businesses that want to accelerate their cash conversion cycles. 

While factoring can be useful, it’s often much better in theory than in practice. The current system in the UK is messy, and there’s a scattered range of providers from big banks to small specialists with complex terms, little regulation, slow systems and plenty of fees. 

To help you get your head around it all, we’re looking at what factoring is, its advantages and disadvantages for SMBs and how we see things changing in the (hopefully) near future.

What is factoring?

Factoring lets you sell unpaid receivables (outstanding invoices) to a third party, for immediate access to cash today. It’s commonly called invoice discounting in the UK, but is also known as debt factoring or invoice financing (although there are slight differences). 

For companies with long payment terms and in need of short-term liquidity, Factoring is an attractive concept. Yes, you give some of your profit to a third party, but you get the capital you need straight away. 

It’s also particularly appealing if you’re not specialised in collections, or if you want a pesky unpaid invoice off your hands–simply pass it over to a third party for them to worry about.

Factoring vs. invoice financing

For the purposes of this article, we won’t worry too much about the difference between these. Both bring in money against outstanding invoices. But there is a slight distinction: 

• Factoring: You hand outstanding invoices to a third party in exchange for a percentage of the total value. When each invoice is fulfilled, the third party gives you the remainder, minus a transaction fee. The third party then chases payment from your customer

• Invoice financing: The third party advances you 70-90% of the value of the relevant receivables upfront and the remainder (minus a fee) once the invoice has been paid. It’s essentially a loan, using your accounts receivable as collateral. Crucially, you still handle the collections from clients. And you’re liable if they don’t pay up

Which you prefer depends on the provider, your own processes and how you weight up the pros and cons of factoring overall. Let’s look at those now. 

Pros and cons of factoring

Advantages

Just some of the reasons why you might explore factoring include:

• Quick access to funds - factoring is helpful if you want or need access to cash sooner than you expect to receive it from your customers

• More predictable income - you can’t always ensure that a client will pay on time and in full, but you know upfront how much you’ll receive through factoring 

• A shorter cash conversion cycle (CCC) - you’re turning expected revenue into cash today, which shortens the whole cycle from money out to money in 

• The opportunity to outsource collections - you may not have a robust collections process, which can make chasing customers a time-consuming, stressful and exhausting experience. Factoring puts specialists in charge of this

• Customer credit checks - because factoring providers will credit check your customers and review outstanding invoices, you’ll quickly learn whether some clients deserve more scrutiny next time around

Disadvantages

There’s no such thing as a free lunch.  Here are some reasons why factoring might not be right for your business:

• Reduced profits - you give a portion of each invoice to the factoring provider, which impacts your profit margin

• High rates - the actual impact on profits can be significant. In many cases, a line of credit may be a cheaper way to tide you over until customers pay

• “All or nothing” criteria - many providers will want to finance all your receivables, rather than a select few. This means profit-reducing fees across the board

• It takes work - while some factoring services are relatively efficient, it can still involve a lot of work–it’s very rarely a one-click process

• There are a lot of providers - some are regulated and others are not so it can be hard to know who to trust

• Impact on customer relationships - your customers may not like being chased by third parties. If you’re worried about this, invoice financing may be a better option than factoring

Factoring for UK small businesses

So what does the factoring landscape look like in practice? UK small businesses have two main options for factoring: traditional banks and unregulated providers.

Traditional banks

Many large and boutique banks offer factoring services for UK small businesses. The upside is they’re banks - they have clear systems and practices. For the most part, banks are predictable. 

Factoring services themselves are not regulated, which can be daunting for small business owners. But banks are, which can be reassuring for the risk-averse. 

Plus, you may already be using them for a bank account or loans, so extending to a new service could be simple. 

Or you may hate your bank. One of our customers described a situation that involved a mountain of paperwork and three months to set up a simple factoring facility. They slogged through this process, only to have the terms change (for the worse) without any warning. 

Unregulated factoring providers

Technically they’re “self-regulated,” but factoring companies do come under the supervision of UK Finance, FCA and NACFB - these cover financial services in the UK.

These providers exist because the banks fall short in some way. Some may be specifically designed to “disrupt” traditional banking services and thus can be faster, easier to use and more dynamic. 

They can also be specialised in specific industries or business models. Or they’ll have tools and apps that integrate with your existing business tech stack.

Finally, some may charge more competitive rates.

But in essence, they’re offering a similar service to the traditional banks. Together, these two players represent the factoring options for small UK businesses today.

Factoring is a good (but not yet great) option

Despite its issues, factoring is a smart and necessary choice for many small UK businesses. It gives you cash today that you’d otherwise wait weeks or months to receive.

But the system is far from perfect, with some obvious flaws. A more responsive, strategic and ideally automated factoring approach would be better for UK businesses.

At Mimo, we believe that a few key changes need to happen:

1. Make accounts payable and receivable the same process

Money in and out are the two sides of the same cash conversion coin. If you can manage them together - within the same tools and process - so you’ll have complete oversight of your cash flow. And you can quickly generate incoming funds through a service like factoring, take a line of credit or generate cash another way.

Ideally, you’d also have the same people handling both ends. Whether that’s the founder or the finance team, it pays to have someone looking at cash flow holistically.

2. Allow for real-time factoring

Working capital management is best when you can react dynamically to your current cash flow situation. If you know that a large payment will be late - and you need those funds - you should be able to secure funding quickly and easily. 

You could even pre-approve a factoring deal, ready to execute the moment you need it. 

Many agreements require you to factor all (or a large share) of your receivables, often far more than you’d prefer. Factoring really needs to be more dynamic, based on need. 

3. Automate as much as possible

One reason why real-time factoring is difficult is that companies are still processing invoices (in and out) manually. That means individual email reminders to clients, entering data into accounting tools and reconciling payments line by line. 

Automate these steps, speed up the process and focus your energy on optimising cash flow. This is really the only way to have a real-time overview of your cash position. 

4. Defragment these systems

Today, you have a web of tools and processes to handle money in and out of the business. A factoring agreement is one more moving part. 

Ideally, you’d bring all of these together to be able to monitor, control and forecast cash flow, and then secure invoice financing or a working capital facility to pay suppliers the moment you need to.

How Mimo can help

Mimo offers easy access to working capital facilities (credit) for just this reason. Instead of a lengthy wait for a bank loan or factoring agreement, with MimoFlex, we advance credit right away. So you can pay suppliers now or up to 60 days later - your choice. 

Plus, with our accounts payable and accounts receivable tools in the same platform, you’ll have a complete overview of all money coming in and going out. 

With Mimo, you can quickly and securely raise credit against your receivables, with no need for third-party factoring services. And with real-time cash flow insights, you can make instant decisions and optimise your working capital, which is so critical for growing businesses.