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Invoice Financing

Invoice financing is a much used facility that allows a business to turn newly raised invoices into cash immediately.It is an increasingly popular source of finance for small and medium sized companies (”SMEs”) in UK.

For example, if you raise an invoice for £10,000 against goods or services that you have supplied to one of your customers on 30 days credit, you can convert this invoice into £8000 of cash within 24 Hours, assuming an advance rate of 80%.

The remainder of the invoice amount, being £2000, is paid to you when your customer settles the invoice.

Obviously you have to pay interest on the initial advance, which is comparable to bank overdraft interest rates and a service charge which ranges from 0.1% to 3.00% to cover the administration and set up costs of the lender.

There are two types of invoice finance: factoring and invoice discounting.

Factoring

Factoring is a flexible and fast growing method of funding the working capital requirements of a company whereby the client agrees to submit copies of sales invoices to the factoring company (either by post or electronically) who in return makes available a pre-agreed percentage of the value of the invoices for immediate drawdown. The percentage available is normally up to 85% dependant on a number of things including type of industry and strength and spread of customers.

The factoring company will maintain the sales ledger on behalf of the client and will contact the customer for payment of the invoices if and when they become overdue.

When the customer has paid the debt to the factor, the client becomes eligible for the balance of the invoice less the factor’s charges.

The main benefit of factoring is in it’s flexibility as unlike more traditional forms of funding, the amount of finance available is tied to sales so extra finance is always there to meet rising sales.

Factoring is available

  1. without recourse where the factoring company will underwrite the credit risk on each customer and will stand the loss if the client’s customer goes bust or
  2. with recourse where the factor doesn’t take the risk but will ask the client to repurchase the debt in the event of the failure of the customer. Naturally this form of factoring is cheaper.

There are two costs involved with factoring. The first is a “factoring commission” which is normally expressed as a percentage of sales and is typically in the range of 0.5% to 2.5% of turnover (less than a traditional early settlement discount) and the second is an interest charge paid on the advances made by the factor until such time as they have been repaid by the customer and is typically 2.5% over Base Rate.

 

Invoice Discounting

Invoice discounting is a variety of invoice finance that unlike factoring is confidential where there is no notice of assignment on the invoices and where the client continues to run the sales ledger and collect in monies as and when the accounts become overdue.
 

Funding Against Invoices

Funding against invoices is available at up to 85% or even in some cases as high as 90% with the balance available when the customer has paid the account.
 

Why use invoice discounting ?

Invoice discounting used to be primarily for established companies with strong balance sheets and proven accounting systems but is now more widely available with even new starts obtaining this type of funding under the right circumstances.

The service charge tends to be cheaper than factoring but some providers will charge for quarterly audits which will push the overall costs up.

Invoice finance facilities have many advantages as well as disadvantages. The main ones are as follows:

Invoice Finance Advantages

Invoice finance facilities have many advantages as well as disadvantages. The main ones are as follows:

Advantages:

  • Access to immediate funding that grows with the business
  • Possibility to release 70-90% of sales ledger turned into free cash within 24 hours; thus alleviating working capital issues
  • Opportunity to outsource the sales ledger management to experienced people employed by the factoring company for a relatively small cost
  • Obtain protection (credit insurance) against bad debt at preferential rates as the factoring company has more clout with an insurance company than your own company
  • No need to visit the bank manager to renegotiate bank overdraft facilities to fund your working capital requirements
  • If your company export or are planning to do so, the invoice finance company could be invaluable for advice and expertise
  • Possible to obtain funding against stock and other assets as bolt-on facilities at advantages rates and terms.

Invoice Finance Disdvantages

Invoice finance facilities have many advantages as well as disadvantages. The main disadvantages are as follows:

Disdvantages:

  • It costs money - service charge and interest charge needs to be compared with other possible sources of finance.
  • Factoring and ‘disclosed’ invoice discounting services are disclosed to your customers.
  • Some factoring companies use outsourced credit control facilities based outside UK. Even though such a set-up would result in lower charges, the quality of credit control offered can be questionable in some instances.
  • Some people still believe, totally incorrectly, that entering into a factoring facility means bad news for your business as they interpret such an arrangement with financial difficulties. 

Invoice Finance issues

Invoice finance facilities have many advantages as well as disadvantages. The main ones are as follows:

Issues to watch out for

  • Minimum charges
  • Length of contract
  • Excessive ‘break fees’ based on unnecessarily large credit limit
  • Availability of trial period
  • Concentration limits of clients
  • Reputation and references
  • Financial strength of the invoice finance company
  • After sales service levels
  • International capability to handle exports
  • Currency conversion facilities available and the associated charges (the author of this article knows of a client who has been charged a 6% fee for converting large sums of foreign currency by a high street bank)
  • Availability of bad debt protection
  • Transfer restrictions of your outstanding invoices
  • Miscellaneous charges – e.g. quarterly audit fees, electronic transfer fees, bank charges etc.

Despite the merits of having an invoice finance facility for a growing business, there are several issues one needs to take into account as mentioned above.

Therefore it is important for you to check them yourself or get someone more suitable such as an experienced business finance consultant before entering into an invoice finance facility. Like many types of business contracts, a badly negotiated invoice finance facility can do more harm to your business than good.