Factoring, a common form of debtor finance, is gaining traction among small-to-medium businesses in Australia. It’s like getting credit from banks based on the money owed to you, without the need for additional assets. However, qualifying can be challenging for some businesses. Let’s explore what factoring is, how it works, and its potential benefits for your business. 

Understanding Factoring: 

Factoring involves a lender (factor) purchasing a business’s trade debts regularly. Unlike invoice discounting, debtors are aware of this arrangement. It helps businesses enhance cash flow by accessing money owed to them, creating additional working capital. The key difference is that, with factoring, the credit control function is outsourced to the lender, allowing you to focus on growing your business. 

Qualifying for Factoring: 

To qualify for factoring, businesses typically need to meet specific criteria: 

• Projected annual turnover of $200,000, although some lenders consider as low as $50,000 for smaller loans. 
• Products sold on normal credit terms. 
• A substantial number of debtors or suppliers to distribute risk. 
• Invoices not older than 90 days from the last day of the month of issue. 
• Efficient debtors ledger and credit assessment system. 
• Preferably, a good credit rating, though exceptions may apply. 

Borrowing Limits: 

Businesses can generally borrow up to 85% of outstanding invoices, potentially reaching 90% for low-risk, strong businesses. Even with a bad credit history, a reputable business can borrow up to 90% but may need a specialist lender. 

Proving Business Income: 

Proving business income for factoring involves providing bank statements, tax returns, Year to Date (YTD) income from MYOB, and projected cash flow statements. Some lenders may not accept YTD income from MYOB. 

Common Borrower Issues: 

Borrowers often face challenges when underlying issues with their businesses are not identified. Banks prefer stable, strong businesses. Applying for a loan to address these issues may still qualify, depending on the strength of the application. Weaker businesses might not qualify as the loan is essentially unsecured. 

Factoring vs. Invoice Discounting: 

Factoring and invoice discounting are similar debtor finance forms, offering comparable benefits. The main difference lies in credit control. Factoring is disclosed with the business managing invoice collection, while invoice discounting is undisclosed, with the lender managing sales ledger and collection. 

Benefits of Factoring: 

Factoring can benefit your business by: 

• Accelerating cash flow. 
• Securing finance without requiring security. 
• Acting as flexible funding, especially for startups. 
• Determining the creditworthiness of debtors. 
• Providing access to funding even under a non-recourse arrangement. 

Involved Parties: 

Three parties are directly involved in factoring: your business, debtors, and the lender. You sell your invoices to the lender, who advances a percentage of the funds. Once paid, you receive the balance amount minus the lender’s fees. 

In conclusion, factoring can be advantageous for businesses needing improved cash flow, flexible funding, and efficient credit control. However, it’s crucial to assess your business needs and costs associated with factoring before applying.