What is Invoice Finance Funding ?
Also known as Invoice Discounting, this set of products is for businesses who trade with other businesses.
B2B sales often involve a period of credit, providing your customer time to pay the invoice. Being able to offer long credit terms can be both an industry norm and a competitive advantage. We’ve seen anything from 7 to 120 days, usually from date of invoice, sometimes from month end. Whilst credit terms can help you win business, it can mean a lot of waiting around for the cash to arrive – that’s where invoice discounting steps in.
When a funder “discounts” an invoice they provide you with a percentage of your invoice value now, typically 50 to 95%, which is great for cash flow and often means you can pay wages and buy more stock in. When the invoice is settled by your customer, you get the balance less charges from the lender.
Funders charge a service fee (sometimes flat sometimes variable) for providing the service and an interest rate on the monies you are effectively borrowing ahead of the invoice being paid. Some funders also charge for drawdowns and money transmission.
Invoice finance isn’t just used for day-to-day working capital. If you have a debtor book and need a lump of cash, then setting up an ID or Factoring facility can release this for you. Businesses use cash to support business acquisitions or even to provide a contribution towards purchasing a premises.
There are three main types of service: Invoice finance, Factoring and CHOCS
Invoice finance, also known as invoice discounting, is normally a confidential service, i.e. the funder does not disclose it is providing the service to your clients. You manage your ledger and collect the debt in as normal. This is typically the cheapest form of financing.
Normally funding is provided against the full debtor ledger on debt up to 90 days, and typically turnover needs to be in the region of £500k. This is seen as a longer term solution where the facility is in place with expectation that it is ongoing.
Selective Invoice Finance
Factoring is normally a disclosed service, but not always. The client will see the details of the funder on the invoices and the funder will chase the debt in their own name. Some clients love this because it keeps customers on a payment structure and someone else is doing the chasing and where required sending letters etc to make sure the invoice gets paid.
In many ways you could see this as the funder “buying” your book debt and then collecting it in as it’s debt.
Factoring can provide a good break between you as a business trying to do more business with your clients and at the same time trying to collect monies in from the same client. Others might find that they would not have handled the collection of the debt in the same way, typically this is only when people are moving from ID.
Factoring is suitable for smaller businesses because the minimum ledger size is in the region of £50k, it also means that if you are a smaller business you don’t have to employ a person to chase the invoices.
Factoring can often be put in place as a one-off hit i.e. an advance on the debtor book without a long term agreement to continue funding as with invoice discounting.
Factoring can either be “recourse” or “non-recourse” i.e. if the client doesn’t pay there is recourse for the funder (or not) to you.
Costs & Considerations
Typical costs include an arrangement fee (but not always), an interest rate akin to an overdraft rate (say 2.25%) and then a service charge which is based on turnover (say 0.22%). Some providers offer a flat fee for the facility regardless of interest rate or turnover.
Initially there will be a debtor verification exercise, which means someone will call a sample of the invoiced clients to verify that the debt is valid, some funders charge for this.
Some lenders charge a renewal fee annually, others will agree a facility for say 24 or 36 months without a renewal fee until the end of the facility.
For most situations, lenders require a good papertrail from purchase order, to invoice, to proof of delivery – this means that if it comes to a situation where your customer is denying the debt, the papertrail provides reasonable proof of debt.
If your debt has contractual elements to it then it will limit the choice of funders – typically anything related to construction, provision of a service or requiring customer signoff or staged payments is contractual. Non-contractual debt is where a product is shipped on a “fire and forget” basis.
Lenders will want to know your level of contra payments, bad and doubtful debt i.e. debts outside of terms of trade, together with any intra-company trading – this is all “reserved” or excluded from the funding provided.
It’s worth considering that moving to ID can take some adjustment, your invoices will need to have the funder’s sort code and account number on them which means a reprint of stationery and educating clients on where to pay, this typically settles down after a payment cycle.
If invoice finance sounds like the product for you, get in touch here.