In a time of reduced bank lending and increased pressure on cash flow, it might be useful to look at the various ways businesses can use their sales ledger to fund working capital.
Traditional invoice finance products:
Factoring
This is one of the oldest types of invoice finance and is where the Factor simply provides funding against a company’s outstanding sales. The Factor also provides a credit control function; their name is clearly displayed on all invoices. This service encompasses the entire sales ledger.
How it works
Copy invoices are uploaded to the Factor who runs a duplicate sales ledger on their system. Upon receipt of the invoices, the Factor will make available to you monies at the agreed Initial Payment level – say 80% (this will depend upon the financial strength and type of your business) with the balance being released to you when the invoice is paid.
Charges
A service charge for providing the service and an interest charge for the time funds are drawn against unpaid invoices.
Notes
Top quality service is of paramount importance, as you are in effect outsourcing the running of your sales ledger, including the credit control function.
Make sure you are comfortable with the level of service that you are likely to receive from your chosen Factor. A product that has a very low headline rate may prove expensive to your business in the longer term as it isn’t sustainable for any Factor to provide top quality service at the lowest price.
When comparing Factoring costs to an overdraft, always take into consideration the additional credit control services provided.
Invoice Discounting
Invoice discounting is a straightforward funding facility secured against the total outstanding debtors. You retain control of debt collection. Agreements are usually provided on a confidential basis so that your clients aren’t aware that you are using this type of funding.
It can be a very flexible form of finance; limits normally move in line with your business so it is particularly beneficial in the provision of working capital.
How it works
Details of invoices are provided to the Invoice Discounter who will then immediately release cash into your account at an agreed Initial Payment rate, commonly 80% (this will depend upon the financial strength and type of your business). The balance is then released upon collection from your customer.
Charges
The Invoice Discounter will make a small service charge for the service and an interest charge for the provision of the finance. This can be a more cost effective alternative to loans or overdrafts, and in most cases gives the lender greater flexibility.
Notes
It is important to balance the provision of good service against cost. Low cost products can prove costly to your business at a later date.
The New Kids on the block:
Traditional invoice finance products as described above have historically been used only to fund straightforward debt. For example, the supply of a non-perishable product to a customer who has signed a delivery note and has been invoiced accordingly.
The development of new technologies and advanced methods of communication have led to the introduction of a number of exciting developments (if invoice finance can be exciting?) including variations on traditional products, the type of debt financed and a number of innovative new products.
One of the most interesting and beneficial new products to have gained some real traction is that of Selective (sometimes known as Spot) Factoring. In this case, the provider will fund individual or small batches of invoices. The big advantage here is that you are not contracted to anything more than the invoice(s) you are funding. The charges will be higher on an individual basis but you also don’t incur any minimum charges or (usually) disbursements. This can be a very cost effective route forward if you only need to access this funding on a periodic basis, for example during a VAT quarter.
There are two ways of accessing these facilities:
Sale of the invoice(s) to a specialist provider
How it works
This is very similar to traditional invoice finance with security being granted to the provider over the invoice(s) to be funded. Collection of the debt normally remains your responsibility.
Charges
There will usually be a fixed fee charged on a per month basis. This can be as much as 5% per month and is therefore much higher than, say, a service charge on a traditional factoring facility. But this has to be measured against the greater flexibility, the fact that you will not be funding all invoices and that there will be no minimum fees to be paid each month.
Notes
It is not quite as simple as offering up one invoice and getting it funded. The provider will often look for other security on other non-funded invoices.
Make sure you are able to repay the facility early if you have been paid early by the debtor to avoid incurring unnecessary charges.
On line auction platforms
This methodology was developed in the US some five years ago by the Receivables Exchange and is now developing fast in the UK.
How it works
Potential clients (sellers of invoices) are reviewed by the auction houses before becoming members. Potential buyers of invoices will pay a fee to become an authorised buyer on the platform.
The seller then puts an invoice forward to the platform and credit checks are carried out on the ultimate debtor.
The invoice is then put into an online auction inviting bids from approved buyers at a suggested discount rate for an agreed period of time.
The auction has a set time period and the best bid wins the right to fund the invoice with monies being transferred to the seller almost immediately.
Charges
A single fee charged per month or part thereof. The rates currently being charged are typically in the region of 1.5% to 2.00% per month.
Notes
The fees charged here are much lower than the other selective factoring service described above and are also very competitive when measured against the total costs of a factoring facility. This just has to be measured against the chance that the invoice will not receive a bid. However, the Auction houses will advise on this and it is my understanding that there are more buyers than sellers at this time in the life cycle of this relatively new product.
We recently advised a client who usually uses a trade and factoring facility with a large UK provider but who was unable to obtain funding for a particular debtor due to their terms and conditions. We introduced them to one of the auction houses and this invoice for circa £100,000 has been successfully funded.
SUMMARY
After years in and around the industry, I am delighted to see the invoice finance business finally moving with the times and really seeking to provide its clients with products that genuinely assist and support business in the current economic environment.
It’s now up to business to understand, and seek out, these products as a viable alternative to bank funding.
As always, if you would like to discuss or comment on any of the above please contact me at john.thompson@transcapital.co.uk or telephone 0845 689 8750.
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