Factoring is an outsourced credit management service that helps small businesses manage their cashflow.

It does this by paying most (around 80-90 per cent) of an invoice immediately after it has been issued to the customer and simultaneously chasing that customer for payment.

Businesses selling to other businesses on normal trade credit terms usually have to wait at least a month between raising an invoice and the customer paying. This usually ties up a significant proportion of working capital, which can often represent a company's greatest asset.

Factors are experts in credit management and because they are able to pay the majority of an invoice the moment it is raised, help alleviate credit risk. The remaining 10-20 per cent of the invoice, minus charges, is paid when the customer pays. More importantly, a company can concentrate on its core business, rather than worrying about chasing payment.

Around 48,000 UK businesses use factors for both domestic and international sales. A typical business using a factoring facility would be selling to other businesses and have an annual turnover of between £250,000 - £5,000,000.

A company using a factor will pay for two things: a fee for the service, around 0.5-3.5 per cent of the turnover, depending on the amount of work involved; and for the cost of the funds used, around 2-4 per cent over the base rate.

In addition, some factoring companies provide credit protection against the risk of the client's customer going out of business. This usually costs around 0.5 per cent of the turnover.