Could invoice finance be a solution?
Invoice finance is a well-established mechanism for financing the working capital needs of a business. The sales ledger is often the largest asset on a company balance sheet. Raising finance against the invoices can provide quick access to cash.
Key points of invoice financing to consider are
- A wide range of creditworthy debtors
- Non contractual invoicing for goods that have been delivered
- A low level of disputes
- A strong paper trail to support the sale of the goods.
Banks will often encourage a client to consider invoice finance as an alternative to an overdraft, usually due to the greater level of funding available and the derisking of the bank’s balance sheet.
There is a strong ‘non bank’ marketplace providing invoice finance facilities to businesses and catering for a wide varieties of industry niches. Contractual businesses can obtain funding but it will come at a higher price and a lower level of advance.
Different types of invoice finance
This provides a full service. Copies of invoices are notified to the funding provider as they are raised following provision of goods to the debtor. The invoices sent to the debtor carry an assignment notice with payment from the debtor being sent directly to the funder in discharge of the debt.
The funder will advance up to 90% of the gross invoice value, this is assessed in the due diligence process.
The funder will usually undertake credit control on the client’s behalf and will run a ledger on the clients behalf.
Funders will provide a small discretionary funding limit where any debtor is funded to an agreed level. Over and above this, debtors will be funded to a limit set by the funder. There is also a requirement for a spread of clients – usually a debtor will be funded to maximum of 40/50% of the total sales ledger value.
Usually confidential, this is transparent to the debtor with the client undertaking their own credit control and reconciling their own ledger at month end to agree with the funders balance.
Generally made available to companies that have a stronger balance sheet and well-established systems that the lender can audit on a regular basis and have integrity within the reporting capability.
Funding Limits are not usually set against individual clients and exposure is usually managed.
Some invoice finance funders provide a half-way house between Factoring and Invoice Discounting where the client undertakes the credit control but funders involvement is disclosed.
Some lenders provide credit protection, which insures against the debtors failing. This is subject to the debtors being creditworthy in the first place and lenders will give debtors individual limits.
Fees for invoice finance
There are 2 key costs here. Service fee which is levied as a percentage of turnover, and discount charge, which is the equivalent of interest. Invoice discounting is usually cheaper than factoring as there is less administration required.
Credit protection is costed as a percentage of turnover and will usually be added to the service fee.
Invoice finance is usually based on a whole turnover agreement where all sales on trade terms are assigned to the lender.
Over recent years, it has been possible to fund selected invoices – normally those to blue chip companies for delivered goods where credit terms are being taken. Specialist funders provide this service which usually requires acknowledgement from the debtor and a variation on any security taken by an existing funder.
Points to be aware of when raising invoice finance….
- Invoice finance is not for every business. The contractual situations and deposit invoicing are not easily dealt with, as well as capital equipment.
- It isn’t always a suitable alternative for an overdraft. This particularly applies to a seasonal business that requires cash flow support year round
- There is often a minimum period of agreement with a notice period thereafter.
- If your bank pushes you towards invoice finance, there are many independent alternatives
- Invoice finance is very good for helping a growing business. However, it can also cause cash flow issues for seasonal business and those with a declining turnover.
Richard Mason of Ludgate Finance wrote this article. Richard explains, “following a move to an advisory role in 2007, it became clear that SME’s were struggling to be serviced by the banks. Alternative finance sources were required. With the advent of peer to peer lending, I sourced and completed over 200 deals. I raised in excess of £30 million to support SME’s in their growth and acquisition ambitions.”