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What is a factoring agreement?


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What is a factoring agreement?

A factoring agreement is the financial contract that sets out the costs and terms on which a factoring company agrees to purchase a business’s outstanding invoices. Detailing everything from upfront costs to whether the arrangement allows for recourse or non-recourse factoring, a factoring agreement is the foundation on which a business can build its relationship with an invoice finance company.

Here we take a look at what a factoring agreement is, how it works, and what to look out for before you sign.

How does a factoring agreement work?

The invoice finance process begins with the signing of a factoring agreement, which sets out the terms on which a finance company will purchase a business’s accounts receivable. It will put into writing the fees associated with the agreement, how the factoring company will go about collecting unpaid invoices from the business’s clients, and who takes responsibility for unpaid invoices.

A factoring agreement with recourse will mean that the business becomes liable for any sums that its customers do not pay to the factoring company, whilst without recourse will protect the business from this liability in the event that their clients do not pay or become insolvent during the factoring period.

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What are the benefits of factoring?

Factoring your business’s invoices could help you to secure a line of finance that skips over gaps in cash flow left by long payment terms. In addition to this, invoice factoring has numerous other benefits including:

  • A quick and easy process that could allow your business to release funds from its accounts receivables long before your clients would have paid up.

 

  • Protection from bad debt risk, if you opt for non-recourse factoring. This means that the factoring company will assume responsibility for unpaid debt, removing this potential expense from your balance book.

 

  • Improved client relationships, as you will no longer have to deal with the invoice collection process which can often strain otherwise positive working connections.

What is the process of factoring?

Invoice factoring, also known as factoring receivables, is a form of invoice finance that sees a company realise money in the short term by selling its outstanding invoices to a factoring company. The factoring company then collects payment of the outstanding receivables from the customers, paying the final balance (minus fees) to the business when the invoice is settled.

An invoice factoring agreement or receivables factoring agreement is needed to put into writing the rights and obligations of the business and the factoring company, and there are various forms of factoring that deviate from the conventional process – including spot factoring, single invoice financing, selective factoring and even reverse factoring.

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Why is it important for a general contractor to know about factoring agreements?

Just as with any business arrangement, it's critical for those entering into an invoice factoring contract to know about the terms and conditions contained within their factoring agreement. A factoring agreement contains terms that set out the cost to your business, along with the responsibilities that fall to both the business and the factoring company. Without insight into these terms, you could leave your business open to unnecessary levels of risk.

It’s always advisable for business owners and managers to read factoring agreements carefully, and to seek independent legal advice where necessary to ensure that they understand all the material elements of the contract.

Common terms in an invoice factoring agreement

Many finance companies use a fairly simple factoring agreement template that covers off similar terms, and so whilst your factoring agreement may contain bespoke terms, it’s worth looking out for the common provisions listed below.

  • Selling Accounts Receivable – every factoring agreement will cover which invoices you will be selling (or ‘factoring’) and will confirm whether your agreement involves all of them or if you will engage in selective factoring – whereby you choose which invoices to sell.

 

  • Creditworthiness – when deciding whether to approve your application for invoice factoring, finance companies will look at the relative creditworthiness of both your business and its customers. You may therefore need to consent to the factoring company’s vetting of your customers in order to reach an agreement.

 

  • Advance Amount – this is arguably the most important element of a factoring agreement as it will set out what percentage of each invoice’s value your business can expect to get upon sale. The remainder will be paid out (minus fees) once the customer has paid up, but as the whole purpose of invoice finance is to release working capital, you’ll want to be sure that the agreement will provide you with the amount you expect to receive upfront for each invoice.

How to terminate a factoring agreement

In addition to the above terms, every invoice factoring agreement should contain terms which concern the fees to be charged as well as the process for terminating the arrangement. This will vary from company to company, but generally you will need to give the factoring company notice that you do not intend to renew the agreement. This advanced notice must usually be given between 30 and 90 days before the contract is due for renewal, or the same period before the date on which you wish your agreement to end.

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Find the best invoice factoring agreement for your business

Invoice factoring can be of huge help to a business’s financial outlook, but it’s important to make sure you’re getting finance on terms that suit you. By using our simple invoice finance comparison tool, you can compare the UK’s best factoring providers and find an arrangement that meets your needs.

From conventional invoice factoring to selective invoice finance and bespoke packages, there’s no longer any need to worry about your business’s cash flow. With the option to sell your accounts receivables, you could have working capital to use in no time, safe in the knowledge that you’ve gotten a good deal by using us.

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