Debt factoring is an external, short-term source of finance for a business. With debt factoring, a business can raise cash by selling their outstanding sales invoices (receivables) to a third party (a factoring company) at a discount.
A business makes sales of £100,000 per month. Its customers are given 60 days to pay their invoices. On average, the business has around £200,000 owed by customers at any one time (receivables). The business needs to raise cash to improve its liquidity.
(1) Wait for customers to pay their invoices (e.g. 60 days)
(2) Sell these invoices to a factoring company for cash now (but at a discount)
With option (2):
The business gets up to 90% of their invoice value in cash now (£180,000)
The debt factoring company then collects the invoice payment from the customers and sends the remaining 10% of the value of the invoice to the business LESS a fee – typically around 3%. The business therefore receives around £14,000, costing them £6,000 in this example.
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