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Factoring: Spot factoring, an interesting alternate factoring scheme for SMEs
For many small and medium enterprises factoring seems like a difficult solution because factors will require a regular number of invoices for them to take care of every year or month. Spot factoring works differently, on the basis of one-time transactions: companies receive an advance from the factor based on a single invoice and do not need to commit to a long-term factoring relationship - which is why such a system is also known as “single-invoice factoring” or “selective factoring”.
I) Principle and advantages of spot factoring
Free from traditional requirements of minimum volume of invoices and minimum monthly fees, this financial product seems to be tailor-made for SMEs.
1) The principle
Spot factoring is a one-time, one-shot deal that does not extend into time - although it can be easily repeated if once again needed. As many small and medium sized businesses suffer from cash flow volatility, and do not necessarily issue a large number of invoices, they will likely prefer that solution to traditional factoring, whereby minimum monthly fees would be collected, even when no invoices have been factored.
Just as with traditional factoring, the name of the factor can be concealed to the final, end-customer who has been delivered the goods or services: it is then called selective invoice discounting.
2) How it works
The factor sets a minimum for this one invoice that will be factored, and no upfront fee is asked.
Once the deal is accepted by the facture, the typical invoice factoring process applies:
- Company A completes the order and issues an invoice to company B,
- Factor checks the invoice and credit-checks company B;
- Factor advances the biggest part of the claimed amounts to company A;
- When company B finally pays the bill, factor credits company A with the remainder of the invoiced amount, minus a fee.
Spot factoring allows:
- Fast access to working capital...
- ... with greater flexibility...
- ... without signing expensive contracts with factors...
-... while keeping the option to not disclose the name of the factor (in the case of selective invoice discounting).
This method however suffers from a few limitations that need to be considered.
1) Increased risk
Because no regular number or amounts of customer invoices is put forward as collateral, factors tend to consider spot factoring as riskier. If the invoice isn’t paid, the factor will lose its investment.
2) Higher management costs
Setup and underwriting procedures will remain the same as for regular factoring, for just one invoice.
3) Minimum invoice size
Therefore, instead of asking for a minimum number of invoices on a given period of time, factors will require... a minimum amount for the invoice they will accept to deal with - and this amount can be as high as a few dozen thousand pounds.
For all these reasons, this financing facility is often more expensive than traditional factoring.
III) Suggested approach
The careful business manager interested in spot factoring will therefore pay extra attention to the following points in order to find a factor willing to take care of his invoices.
1) Early selection of factor
Early selection of the factor prevent receivable depreciation: old invoices present more risk and will deter factors to take on the job.
2) Unclaimed assets
Invoices need to be “clear”, which means, they shouldn’t have already been promised as a collateral to another factor or lender.
3) Tidy accounting
Neat bookkeeping will provide evidence to the factor that the invoiced company usually pays on time, which makes the approval process faster, increases the advance amount and decreases the interest rate.
4) Honest reporting
In its essence, this scheme is directed to companies with little collateral and weak credit ratio, so it’s better to give a clear picture to the factor of the financial situation of the company early on in the negotiation process to get a fast approval.
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