Contractors, is your agency or umbrella reliant on invoice factoring?

When times are tough, everyone in business knows how important cash flow is.

We might be starting to hear positive noises about the post-covid economic recovery. But for thousands of businesses, just remaining solvent will likely remain their main preoccupation for the next year or two.

When cash flow becomes volatile because you cannot tell if the people who owe you money are going to be able to pay on time, it is easy to understand why companies turn to invoice finance options. The harsh rule of solvency is that it doesn’t matter what you might be paid in a month or two’s time. All that counts is being able to pay your own creditors now, writes Adam Home, senior credit manager at Safe Collections.

What is invoice factoring and why does it matter to contractors?

Invoice factoring or discounting is attractive to many contractor sector businesses because it involves realising assets early rather than taking on extra debt. Instead of an umbrella or agency waiting up to 90 days or more for money they are owed from an end-client, factoring providers buy or finance the ‘debt’ and pay a percentage upfront.    

This allows an agency, say, to have one set of payment terms with an end-client, and a different and often shorter credit period with their contractors. The factoring company will often take over credit control duties too, saving the time and hassle of chasing late and non-payments.

However, there are risks involved in using invoice factoring as a cash flow solution. In the contractor sector, we’ve seen a few businesses go under this year, and all such businesses were heavily reliant on factoring or invoice discounting. It’s a worrying trend and unfortunately, despite covid’s recovery being more in sight, one we only expect to get worse in the next two years.

No hiding from non-payments

Employment agencies are a prime market for factoring services. As intermediaries between companies and the contractors they hire, they have large invoice books, often long credit terms and equally large payment liabilities.

With so much work and effort involved in managing all those credit accounts, it can seem like an obvious ‘quick fix’ to finance the invoices through a factoring company, getting cash released quickly to pay their contractors in time.

The problem is, once you shape your cash flow around the instant fix factoring gives you, it’s a very hard habit to shake. You soon find you can’t do without that easy cash-guarantee, so any interruption to this flow is felt disproportionately. If an agency or intermediary wants to change providers they can often find they are locked in, as their cash reserves likely won’t cover the period when no finance is available. 

Recourse factoring

In addition, the more you use invoice factoring, the more exposed you are to non-payment.

Yes, the factoring company might take on credit control responsibilities for the debt they acquire. But no, if a client of yours doesn’t pay, it’s you who are liable for the debt; just as you would have been without the finance in place!

This is known as ‘recourse factoring.’ You can find non-recourse factoring services, which essentially insure you from the liability should a client not pay, but these are more expensive. So they constitute a further hit to margins. They also often take a very hard line with any perceived financial risk and only provide ‘cover’ to clients they know will pay

With a standard recourse factoring deal, the normal practice would be for the provider to subtract any unpaid invoice value from the next round of payments. So let’s say you have financed £100,000 worth of invoices, with a 90% upfront payout each month, providing you £90k in cash to service your own liabilities.

But then one month, let’s imagine, a client doesn’t pay a £15,000 invoice. That would mean your next payment from the factoring company would suddenly drop from £90k to £75k. That’s a big hit to take on your cash flow. Similarly, you might find a factoring company withholds payment if an invoice is in dispute.

The downward spiral

It should interest contractors using them to know -- as a recruitment agency, this type of interruption can be fatal. As not only does the agency now have a £15k hole in their next month’s finance, they also still have an unpaid invoice on the ledger for the same amount! This may be a problem that can be overcome where there are cash reserves available to cushion the loss and pursue the outstanding payment. But if not, any interruption can spiral into serious concerns.

So invoice factoring is far from a ‘cure-all’ for cash flow issues. In fact, at a time when we can expect non-payment of invoices to be on the rise because so many businesses are struggling, there’s a good argument to say that invoice factoring risks exacerbating underlying problems, or amplifying the disconnect in client-contractor payment terms.

Contractor protections are incoming

High exposure to factoring among recruitment firms also has a knock-on impact for the whole contracting sector. In my next piece for ContractorUK, we’ll explore what the risks are for contractors, how contractors can definitively identify agencies that finance their invoices and what steps contractors can take to protect themselves.