Business Finance Series – What is Invoice Finance? – Part 6

I am continuing my series of blogs looking at invoice finance.

As I’ve explained in previous weeks, there are a variety of different options available when it comes to invoice finance. They all work in different ways and have different qualifying criteria, but essentially the main types of invoice finance are as follows:

• Factoring
• Spot factoring
• Invoice discounting
• Selective invoice discounting

Last week I started to look at invoice discounting. However, it’s a big subject, so I explained last week that I would continue looking at invoice discounting this week.

To understand invoice discounting fully, you will need to read last week’s blog in conjunction with this week’s. So, here is invoice discounting part 2!

What are the costs of Invoice Discounting?
In general, invoice discounting is cheaper than factoring. This is because, invoice discounting requires a lower level of service from the lender. With factoring as described in a previous blog article, the lender or finance provider carries out the credit control function on your behalf, collecting payment and chasing invoices as required.

With invoice discounting, you carry out all the credit control function yourself, with the result that the finance provider in effect “has less to do”. This is reflected in a lower cost structure for invoice discounting.

That said the cost structure is the same as with factoring. So, in other words it is in two parts; a discount charge and a service fee.

The discount charge is in effect an interest rate against the funds drawn and is expressed as a percentage above bank base rate. Typically, the discount charge on invoice discounting is in the region of 1% to 3% above bank base rate.

The service fee is the finance providers cost for running the invoice discounting facility. The service fee will be less than the service fee for a factoring facility because as already explained above, you are running the credit control function yourself within your business. The variables that will affect the amount of the service fee include such things as the volume of invoices, the size of invoices, the industry sector you are in and the strength and stability of your business.

All of that said, as a guide, the service fee for an invoice discounting facility will be in the region of 0.2% to 0.5% of the turnover of your business, normally paid on a monthly basis.

It is also worth pointing out that there may be additional costs for an invoice discounting facility. These can include such as minimum usage fees, transaction fees and other administrative charges.

Lenders are not all the same in the way they structure their invoice discounting facilities, nor indeed in the way they charge for the facilities they offer. So, it’s worth “shopping around” to find a facility that works for you at a cost that you are comfortable with.

What are the advantages and disadvantages of Invoice Discounting?
Firstly, invoice discounting offers many of the same benefits as factoring. Fast access to working capital to inject into the business, an improved cash flow position and the opportunity to fund the growth of your business as a result.

The main difference of course, is the independence. This is because you manage your own credit control function. This means that because the credit control function is carried out in-house, you continue to control how the business is run, you are able to maintain your existing customer relationships because the finance facility is confidential, whilst at the same time benefitting from the lower fee structure that comes with an invoice discounting facility.

All of that said, compared with factoring, invoice discounting comes with a higher level of responsibility. This is because, you need to keep your sales ledger consistently updated, make sure your customers pay their invoices on time and ensure your finance provider is kept updated at all times.

So, as you can see there are many advantages of invoice discounting, but there are also some disadvantages. In summary here they are:

Advantages:

• You have fast access to funds thus improving your cash flow within the business.
• It’s confidential.
• It is cheaper than factoring.
• You have complete independence to continue managing your credit control function.
• You maintain your ongoing customer relationships.
• Bad Debt Protection – you have the option to protect yourself against customers insolvency, giving you a greater level of security.

Disadvantages:

• Increased responsibility to handle your credit control function efficiently and effectively. This may mean having to introduce new systems or controls to meet the finance providers requirements.
• Not suitable for small companies or sole traders.
• Generally, not suitable for businesses operating in the B2C sector.
• You must liaise with the finance provider and give regular reports and updates about the state of your sales ledger.

Is Invoice Discounting right for you?
Having gone through how invoice discounting works, and the costs involved, as well as the “pros and cons”, the question you must ask: is invoice discounting right for your business?

To help you answer that question, let me explain the four main variables that finance providers or lenders need to think about in considering whether your business is suitable for an invoice discounting facility.

These variables provide information to the finance provider about how compatible your business will be. This is because, unlike factoring, invoice discounting is more suited to a business that has been trading for some time, is relatively successful and has an established credit control and cash collection function already in place.

1. Business Stability:
You need to be able to show a track record of your business being “stable” in order to provide proof to a finance provider that you can manage the credit control function. It varies from lender to lender but as a general guide, a lender providing invoice discounting facilities would normally expect your company to have been trading for a minimum of 2 years.

2. Annual Turnover:
It varies between lenders, but a lender is likely to expect the annual turnover for your business to be a minimum of £250,000 in order to qualify for invoice discounting. Some lenders have an even higher minimum turnover figure, As a general guide, the higher your turnover and the larger your client database, the more likely it is that you are able to manage your sales ledger in-house.

3. Invoice Credit Terms:
This is to do with the normal credit terms you provide when you issue your invoices. Lenders have an expectation of these credit terms being somewhere between 30 and 90 days. A few lenders will accept payment terms of up to 120 days, but credit terms of this length are viewed less favourably because of course the lender is having to wait longer to receive payment.

4. In-House Capabilities:
Finally, and perhaps most importantly if you are applying for an invoice discounting facility, you must be able to demonstrate that your business has an established and effective credit control department and can deal with collections appropriately.

This is an important point and will be very much a part of the lender’s decision making process. This is because, the lender is relying on your company’s ability to be able to collect payment from clients within the agreed credit terms, as lenders rely on payment of invoices to repay their facility.

Invoice discounting is by some distance, the most popular type of invoice finance. It provides flexibility, supports the cash flow requirements of a business and gives the independence a business owner simply doesn’t get with a factoring facility.

But remember, as the business owner, you will be responsible for managing the sales ledger and that might mean increased and improved management capabilities. As a result, invoice discounting is not for everyone, so think carefully before you decide about the best way forward.

Next week we’ll finish off this series of blogs on invoice finance, by looking at selective invoice discounting.

In the meantime, if you are currently experiencing cash flow problems within your business and want to talk to an expert, then email us at keith.park@fundingtrack.com or give us a call on 020 8949 2122 and let’s see how we can help.