Invoice finance

Factoring and invoice discounting have become mainstream sources of lending. What do entrepreneurs need to know before appointing a provider of this form of working capital?

1. What is it?
Factoring is when a business hands over its sales ledger to a third party, enabling the company to draw funds against money owed.

The factor will usually offer an immediate advance (within 24 hours) of up to 85 per cent of approved invoices, with the balance paid when the debtor pays the debt, which is collected by the factor.

Invoice discounting also gives firms the option to draw money against invoices, but they retain control of sales ledgers and collect the debts as usual, so customers are none the wiser.

The invoice discounter will visit your business and review your finances to check the company’s suitability for invoice discounting. The invoice discounter will then pay a percentage of the value of the invoices, which can be anything between 70 and 85 per cent.

2. Pros and cons
Factoring provides a quick and often significant boost to cashflow. Businesses can save time chasing up outstanding invoices and, of course, it means you can avoid the awkward conversations relating to unpaid bills.

You can negotiate competitive prices as there are plenty of companies offering such services. Sometimes factors also give you information about the credit details of your customers, which could save you time as you would not have do your own credit checks.

The obvious disadvantage is the reduction in your profit margin, because it comes at a price. It will also mean you won’t be able to use book debts as security, so it potentially decreases the scope for other borrowing.

Some customers prefer to deal with business owners rather than factoring companies and if the factor isn’t as efficient as you when it comes to customer care then this could affect your reputation.

3. Who can use it?
Most factors usually work with businesses with a turnover of more than £50,000, although there are firms out there willing to work with newly established businesses, but they will probably charge more due to the risks associated with start-ups.

Factors prefer companies to have a spread of customers as this reduces the risk if a customer was to default on their payment.

Businesses that sell to the public are least likely to be accepted by a factor, as they mainly deal with commercial clients. Factors do not like to deal with untrustworthy companies, or those that have large numbers of small invoices.

4. How is it used?
Business owners use invoice finance for a number of purposes, the most common one being working capital. Start-ups often find it difficult to get loans due to a lack of security, so invoice finance can act as a temporary stop-gap.

Steve Stuart, partner at corporate finance advisor Brabners Stuart, says invoice finance is a great way to aid organic growth as funding grows with the business.

You also get access to larger amounts when order books are full and, unlike like a loan, you do not have to worry about making repayments even if no money is coming in.

Invoice finance is also used for turnarounds because it releases value that is tied up in unpaid invoices.

Because of this quick release of cash, a business owner is not usually required to offer security as the invoices themselves act as security.

Invoice finance is also a popular way of raising cash to fund management buyouts, management buy-ins, acquisitions and mergers.

5. Cast of thousands
Invoice finance has continued to grow in popularity, according to official figures from the Asset Based Finance Association (ABFA).

The latest statistics for the third quarter of 2011 show that total advances from ABFA members reached £16 million, an increase of nine per cent on the £14.6 million reported in the same period in 2010.

Total funding available reached £23.2bn, while pure invoice finance (advances against debt) was up 12 per cent to £13.4bn, compared with the previous year when it reached £12bn.

However, the number of invoice finance clients remained fairly static, increasing by just 16 from 41,556 in 2010 to 41,572 in Q3 2011.

6. First things first
So what does an entrepreneur need to consider before appointing an invoice finance provider? The considerations are very similar to those for funding requests presented to a bank or other loan provider. Business owners will have to ensure their accounts are up-to-date, as invoice providers will want to give them the once over.

Neil Dobson, corporate development director at Barclays, says it is important to be specific about how much finance you require and when you need it by.

He adds, “In a competitive world, the cheapest pricing or the first to open their cheque book is not necessarily the most appropriate facility and one should always consider the longer-term relationship that is being formed and the added value that the provider brings.”

Sue Weighell, a financial consultant who trades as Delta Solutions, says that you could see what your bank has to offer in terms of invoice finance. But, she says it is important not to make any rash decisions and it is best to try and get quotes from two or three providers before you commit to anything.

Asking fellow business owners is also worth +considering, says Weighell.

Paula McGrath, corporate finance partner at Brabners Stuart, says, “It is important to choose a supportive partner who understands your business cycle. Pricing shouldn’t be the deciding factor when choosing an invoice finance provider.

“It is of paramount importance to focus on the service levels, the availability of funding and limits of cover offered per customer so you can access the level of funding needed to suit your requirements.”

7. With my reputation?
You will need a provider that meets your needs and one that you can trust, as large sums of money are usually involved when it comes to invoice finance.

Weighell says that you should never be afraid to ask questions relating to your case, as you will need to fully understand the procedures and, more importantly, the charges involved.

David Banfield, president of the Interface Financial Group, says that you should look for a provider that can demonstrate longevity in the marketplace.

“Providers that have been in business for 20, 30 or even 40 years clearly must be doing something right as they have continued to stay in business and meet their clients’ expectations,” he adds.

8. Suits you, sir
If you wanted to buy yourself a new pair of shoes then you would go to a shoe shop, not a bakery. Similarly you should seek out a factor or invoice discounter that knows your business and the industry it is in.

If you have a manufacturing company, it would be wise to go to a provider who deals with the manufacturing sector, as they will have knowledge of how your business works.

Dobson says it is important the provider “fully understands” the business sector and any issues both in terms of its assets and financial performance.

It is important to shop around in order to find a provider that will assess your individual business needs.

9. Never accept a first offer
Like any business deal, it is always worth negotiating to see if you can get a better deal. Providers will look at each case uniquely so, if business is booming, you will have more room to negotiate than, say,
a business that is not doing as well as it could be.

Dobson says the invoice finance market is still competitive, despite the “turbulence in financial markets”.

“Naturally, the credit grade of the business will be a key determinant as to the rates that the invoice finance house will be able to table.

“However, a business that is able to provide good quality information in an open and transparent manner will be viewed favourably and possibly assist the provider to sharpen their pencil,” he adds.

Weighell says you should always challenge an offer if you feel it could be improved. “A provider will have more confidence in your ability to pay if you understand your current financial position, have up-todate management accounts and a good debtor’s ledger.

“Have all the information ready when you meet providers and make comparisons to get a deal that suits you. They are in the business of lending and want you to become a customer,” she states.

10. Face time
Banfield says it is important that you get to know your provider. Funding of any nature, he says, should never be conducted over the internet or by telephone.

He says it is vital that you meet your provider on a face-toface basis.

“For an entrepreneur, it is also important to understand what the provider’s approach to decision making is.

“Does an application have to pass through a number of approvers’ or committees, what timeframe is involved, or can the person talking to the entrepreneur actually make the decision to move forward?” Banfield concludes.

Picture: Cheap isn’t always cheerful: Neil Dobson