Like many other small-to-medium-sized business owners, you might encounter cash flow problems involving slow-paying customers. If you don’t have large cash reserves, this gets in the way of you reinvesting money where it matters most and helping your business grow.
When faced with situations like this, there are numerous options available to you. Selective invoice factoring is one of them; yet as with any financial product, there are pros and cons for you to understand and weigh up.
With that in mind, we’ve written this handy guide to selective invoice factoring. Read on to find out everything you need to know, including what it is, how it works, and the advantages and disadvantages that come with it.
Selective invoice factoring is when you select a set of specific unpaid invoices from your debtor book and use them to take a loan from a factoring company. It’s an effective way of freeing up money that is locked in slow or late customer payments so you can use it in business operations during the wait.
Invoice factoring is one of two main forms of invoice finance. Like the other main form, invoice discounting, factoring allows businesses to boost their cash flow by borrowing money against invoices from their customers.
A key difference with invoice factoring is that the third-party provider manages your sales ledger and collects the money owed by your customers themselves.
The difference between selective invoice factoring and the other types of invoice factoring lies in the number of invoices that the business uses to borrow against.
Invoice factoring lets you borrow money against your entire debtor book.
However, selective invoice factoring doesn’t require you to use your whole debtor book. It lets you pick and choose exactly which invoices you want to use.
The terms spot invoice factoring and single invoice factoring are often used as synonyms for selective invoice factoring, yet they mean slightly different things. Single invoice factoring involves just one invoice, as does spot factoring. Selective invoice factoring involves a set of invoices that is smaller than the entire debtor book.
These terms aren’t used consistently within the market. So, in this guide, we’re using selective invoice factoring to mean any invoice factoring that gives you control over which invoices you use – even if that’s only one.
The process of selective invoice factoring has three stages:
· Invoice selection: When you want to release cash from your debtor book, you choose a set of unpaid invoices to advance with a factoring company. If your request is approved, you agree on a fee for the service.
· Initial funding: The factoring company then verifies the invoices and advances a percentage of the value to you, typically around 70-85%.
· Final instalment: When the customers pay the invoices, the factoring company collects the debt and pays the remainder to you – minus their pre-agreed fee.
You can use selective invoice factoring to get a quick advance on any outstanding customer invoices. It’s especially effective if you have a set of reputable blue-chip clients who are slow to pay. Since factoring companies see such clients as low risk, they’re more likely to accept your request for selective invoice factoring.
Broadly speaking, you can use your advance to bridge the period between issuing the invoice to the customer and when they pay. That means using that money for whatever you would use the customer’s payment for – whether that’s investing in a new project, paying taxes or anything in between.
The first thing to know is that there isn’t any standard cost for invoice factoring.
Some factoring companies offer a structure in which there’s a single, upfront fee. However, most factoring companies offer variable fees.
While different factoring companies may charge you for a variety of reasons depending on your situation, ranging from setting up the facility to conducting an audit of your business, some costs are always present.
The three main variables involved in the costs of invoice factoring are the interest rates on the loans, the factoring period and the service fee.
The interest rates for selective invoice factoring are also called factor rates. They’re typically set anywhere from 1.5-5% over the Bank of England base rate and are due for each invoice. Generally speaking, the more value you give to the factoring company in terms of size and number of invoices, the lower the interest rate will be. This means that by choosing higher-value invoices when applying for selective invoice factoring, you can get better returns on your fees.
This is the amount of time your customer takes to pay their invoice. Factor rates are calculated as percentages, often on a weekly or monthly basis. So, the longer the factoring company must wait before receiving the payment, the more you have to pay in interest.
H3: The service fee
The service fee is charged as a percentage of the overall value of the invoices you advance. This is generally 0.75-2.5% for selective invoice factoring – higher than for invoice discounting since the factoring company takes on the extra work of chasing invoices.
· Low risk: There’s little risk involved for both parties. You don’t need to use any personal guarantees or collateral to get the money. And since the invoices are for work that has already been completed, there’s little risk for the lender too.
· Greater total invoice value: Factoring companies want invoices to be large enough to be worth their while. Using selective invoice factoring, it’s easy to build up a sum that meets factoring company minimums.
· Greater financial control: By selecting exactly which invoice you want to advance through the lender, you retain more autonomy and control over your business’ finances compared to using your entire debtor book for invoice factoring.
If selective invoice factoring sounds like the type of funding that your business needs, then get in touch with a member of our helpful team. Invoice finance is one of our key offerings at Nucleus, letting you borrow anywhere between £100K and £50M.
· Higher interest rates: The factoring rates charged for selective invoice factoring are higher than the Bank of England base rate and may be higher than the interest rates for traditional banking options.
· Higher service fees: Compared to invoice discounting, selective invoice factoring has higher service fees. Factoring companies charge this for their greater involvement in managing invoice collection.
· No confidentiality: Since the factoring company will take responsibility for chasing unpaid invoices, your customers will learn that your business is using invoice finance. Customers may take the factoring company’s behaviour as a representation of your business or may object to having their debts placed in the hands of a third party.
As with all financial products, selective invoice factoring has its downsides. If it doesn’t seem like the right option for you, why not explore the other types of funding available?
If you operate any UK-registered business that invoices B2B customers for products and services, you could be eligible for selective invoice factoring. This includes all types of small businesses, including start-ups and sole traders.
Depending on the factoring company, your business may need to have a minimum annual turnover, often upwards of £100,000. The factoring company is also likely to consider the quality and trustworthiness of your customers, including their credit scores.
Now you have an idea of what selective invoice factoring is and how it differs from other forms of invoice finance. That means you’re better able to decide if it’s the best option for your business.
It depends on the nature of the cash flow problem you’re trying to solve and how you want to solve it. Make sure you’ve considered these things as well as the pros and cons of selective invoice factoring before you commit.
If you decide that selective invoice factoring isn’t for you, there are plenty of other types of funding out there that you can use.
Supporting growing businesses with the right funding is our speciality at Nucleus. For any questions or queries regarding business finance, please don’t hesitate to get in touch with a member of our friendly team.
4 August, 2022