PracticeConsultingFactoring – Breaking out of the bank and into asset-based finance.

Factoring - Breaking out of the bank and into asset-based finance.

According to the Bank of England, the UK is the largest factoring market in the world accounting for nearly 20% of factoring business (see diagram 1). But does topping the world's factoring league actually help UK business in any way?

Naturally enough, the factoring industry would say yes. Factoring and discounting has grown significantly over the last few years in the UK.

The latest figures published by the Factors & Discounters Association showed that the annual turnover exceeded £60bn for the first time.

And with the economy in good shape, the industry can look forward to new records. David Marsden, FDA chairman says: ‘The figures show that working capital provided to the SME sector grew by 14% in the year to stand at over £4.7bn at 30 September. Passing the £60bn turnover milestone demonstrates that asset-based finance is a force to be reckoned with.’

Perhaps equally important as the amount of cash the industry provides, is the increasing number of companies using the service. By September 1999, for example, the industry boasted of other 25,000 clients among UK businesses, a growth of 6% in the year. And David Richardson of the FDA reckons figures due out soon will show even stronger growth.

The selling pitch of the factoring company is well known and, like all good sale stories, is both compelling and easy to understand. The factoring company will buy your trade debtors and give you 80% to 85% of the value of those debts immediately. So while the factoring company waits for the cash to come in you can concentrate on growing your business. And the other main advantage of factoring is the more straightforward relationship with the company lending you money. They’re lending against a tangible asset, so no more grovelling to the bank manager to keep the overdraft facility going.

In recent years it has been the small and growing business sector where the factoring industry has concentrated most of its considerable marketing and selling firepower.

Richardson says: ‘Over the last few years the factoring and discounting industry had broadened. Some (members) are going for big-ticket stuff, targeting companies with turnover of more than £50m. At the other end some will handle firms who only turnover £50,000.’

According to the FDA, at the end of the second quarter of 1999, nearly half of FDA members’ clients had turnover of less than £500,000, although these clients accounted for just under 9% of the total money advanced (see diagram 2). Companies with turnovers between £1m and £5m accounted for the largest proportion of advances at 33.9%. The factor’s business by sector reflects the shape of the UK economy. The service sector narrowly beats manufacturing as the largest use of factors followed by distribution with transport and other a long way behind.

The growth in factoring has been spurred by the realisation that too many SMEs have been over-reliant on the overdraft facility to finance anything from working capital to long-term investment projects (see case study). The Bank of England has made efforts over the last few years to emphasise what it calls ‘the importance of finance being appropriate for the use to which it is put’. When the Bank did research into the products used to finance business they found that factoring was just one of a number of sources of cash. (see box below). And for all the growth of factoring over the last few years, an examination of the other sources of financing suggests there is room for more growth.

The figures from the British Bankers Association for the end of June 1999 show that lending to small businesses was £36.1bn – the highest level since 1994. Term lending and borrowing on overdraft each increased by £100m between March 1999 and June 1999, reaching £25.1bn and £11bn. Over the last few years the total lending by banks has risen from £34.1bn at the end of 1996 to £36.1bn by the mid-point of last year. The figures also show that many businesses have little need to worry about finance – deposits in the same period increased from £27.8bn to £34.4bn.

So while banks were owed £11bn in the form of overdraft in June 1999, the amount owed to factoring companies – so called pre-payments – amounted to around 40% of that figure at £4.4bn. In 1996, the same ratio was just under 30%, so it can be seen that factoring is making ground on traditional bank lending.

Maurice Fitzpatrick, an economics expert with medium-sized firm DFK Chantrey Vellacott, says that any mechanism that increases liquidity in the non-financial sector should be viewed as good for the economy. He says: ‘Factoring is a disguised form of borrowing. It is simply moving liquidity out of the banking system into non-banking businesses.’

The economic question is whether factoring is the cheapest form of borrowing for the sector. Fitzpatrick adds: ‘It is unhelpful in a microeconomic sense if the effective rate of interest charged is more than other forms of borrowing.’

But to the minds of many small businesses factoring represents more than just borrowing money. It represents outsourcing of a key problem – cash collection (see case study).

From the banks’ point of view the small-firm sector represents a large and growing market. Although it offers considerable scope to enhance banks’ profitability, there are significant risks. In the last recession in the early 1990s, the banking sector suffered large losses from its loans to small businesses. From the businesses point of view they too appear to have learned their lessons from the last economic downturn. According to the Bank of England: ‘Small firms, on aggregate, are markedly less dependent on external finance. Recently published research has shown that only 39% of small businesses sought external financing of any kind between 1995-96, compared with 65% in the 1987-90 period.

‘The proportion of external finance for small businesses accounted for by traditional bank borrowings has also declined. This partly reflects shifts towards factoring and assets based finance (such as factoring) – although much of this is itself provided by finance subsidiaries of the main clearing banks.’

This shift is reflected in the growth of factoring which over the past 10 years has seen volumes up on average 20% each year. This growth has occurred mainly since 1993 and has been heavily concentrated in domestic invoice discounting.

Whether the industry can maintain that rate of growth and really start to challenge the continuing dominance of the overdraft and term lending remains to be seen.


Fashion designer Lezley George has complex cash flow issues. As a seasonal business with several months each year given over to the production of new garments, there are periods when the business has a heavy outlay and a moderate income. But this is the time when George needs to access cash the most to pay suppliers for the material used during the manufacturing of next year’s collections. On top of that, 60% of the clothes she makes under her own Lezley George label are exported abroad from her base in Shoreditch, London. Two of her most successful markets are Europe and the US, regions that are notorious bad payers. The business turnover is about £600,000 and is growing. When she went to her bank to extend the overdraft they suggested she considered factoring. In discussion with her factoring company, Lombard NatWest, George reorganised her business. She restructured her delivery cycles and sent smaller shipments to clients on a more regular basis so that she could plan her cash flow better, and she knew with factoring that funds would always be available. According to George, however, the most important benefit factoring brought to her business was the credit control facility. One minute she would be working hard to make the sale and the next minute she would be chasing to get the money from previous sales – often talking to the same person. Now that the finances are more under control the bank has extended the overdraft so she is able to buy the materials she needs to manufacture garments out of season and can rely on the factoring company to ease the cash flow problems when the selling season begins.


With factoring the book debts are bought for cash – usually around 70% to 80% of their value – and then the factor also manages the sales ledger and collection of the money. Invoice discounting is confidential and the sales function is kept in-house. According to the Bank of England, most small businesses are forced to use factoring rather than invoice discounting, despite wishing to keep the credit management in-house. This is because they are too small to be considered for invoice discounting. Invoice discounting is only offered to larger businesses because it is not economic, says the Bank of England, to provide it on a small scale at a price that would be attractive to the finance house. Finance houses, on the other hand, say it’s all about risk: smaller companies just have poorer credit management controls.

Source: Finance for small firms, Bank of England, January 1999.


– Credit cards

– Other private individuals partners/working shareholders

– Factoring

– Hire purchase/leasing venture capital

– Bank

Note: not in any order.

Source: Bank of England.

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