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Time is not your friend if you have slow cash flow...

Introduction

The UK market for factoring and invoice discounting continues to grow year on year.

Unlike overdraft facilities which are pre-agreed and relatively rigid, invoice finance provides flexibility as sales grow without the need to re-negotiate the entire facility.

Most businesses trading on credit terms can now be supported, whatever they are involved in providing, the trade debts are on a business to business basis and are "recoverable".

The overriding concern for a finance company is how "recoverable" the debts are in the event that the company ceases to trade or becomes insolvent.

In most cases, the production of a formal offer letter comes following an audit at your premises to perform "due diligence". The factor/discounter will need to audit how well the business is run, what systems are in place and verify that the financial statements and business plan make sense.

The commercial reality today is such that each company will take a differing view of risk and "recoverability" so that funding trade invoices is more a question of finding the right provider with the right view of your business.

If you are not sure that your current debtor book is fundable due to accounts being over 90 days old then talk to us about our UK debt recovery and international debt collection services. We have the experience and expertise to turn your debtor book into a funding proposition.

What is Invoice Discounting?

What is invoice discounting and how does it work? Invoice Discounting provides a cash flow solution for business.

How does invoice discounting work?

The invoice discounting company (discounter or invoice discounter) will buy the trade debts (also known as accounts receivables, or your sales ledger) of the business at an agreed funding rate.

Discounters typically advance 80% to 85% of the face value of valid invoices, for example:

A company raises new sales invoices of £100,000. Based on the 85% advance it would generate a cash injection of £85,000. This releases working capital that would otherwise be "locked up" and provides immediate cash flow enabling you to pay creditors and use that cash for expansion and growth.

The discounter will then continue to provide you with up to 85% of the value of new sales invoices, normally within 24 hours of you raising them. The other 15% of the value of your sales invoices is passed onto you (minus fees) when the customer pays.

There are some circumstances where overpayments can be arranged, however this type of advance will be determined on the basis of how the facility has been maintained and if a successful and trustworthy transactional history has been built up.

Once the facility is in place, there is no limit to the amount you can borrow as the level of finance is directly linked to the level of sales. So as your business grows so does the amount of funding available to you. This is in sharp contrast to bank overdrafts, which require regular re-negotiation and arrangement fees.

What are the criteria for invoice discounting?

Invoice discounting facilities are normally made available to established businesses with turnovers in excess of £250,000.00 which have good systems in place to ensure reliable collections from their customers.

How does invoice discounting differ from factoring?

The fundamental difference between invoice discounting and factoring is that you are responsible for the collection of cash from your debtors. The payments that you receive are paid into a nominee bank account which is administered by the invoice discounter.

Where a Confidential Invoice Discounting facility (CID) is in place your customers are unaware that a discounter is funding your business.

For any business the potential for bad debt will always be an issue. If you are concerned about bad debts, many discounting companies can provide a facility that will include bad debt insurance protection for additional security.

What is Factoring?

What is factoring (or invoice factoring) and how does it work? Factoring provides a working capital solution and operates in much the same way as invoice discounting except this type of funding is a "disclosed" facility which means that your customers will be fully aware of the factor's existence. 

How does factoring work?

Factors typically advance 80% to 85% of the face value of valid invoices, for example:

A company raises new sales invoices of £100,000 which contain an instruction to pay the factor. Based on the 85% advance the company would receive a cash injection of £85,000. This releases working capital "locked up" that will improve the cash flow enabling you to pay creditors and use that cash for expansion and growth. The factor will send out debtor statements, chasing letters and will also contact debtors by telephone to ensure prompt payment. The factor will then continue to provide you with up to 85% of the value of new sales invoices, normally within 24 hours of you raising them. The other 15% of the value of your sales invoices is passed (minus fees) onto you when the customer pays.

For any business, the potential for bad debt will always be an issue. If you are concerned about bad debts, many factoring companies can provide a facility that will include bad debt insurance protection (commercial trade credit insurance) for additional security.

There are some circumstances where overpayments can be arranged, however this type of advance will be determined on the basis of how the facility has been maintained and if a successful and trustworthy transactional history has been built up.

Once the factoring facility is in place, there is no limit to the amount you can borrow as the level of finance is directly linked to the level of sales. So as your business grows so does the amount of funding available to you. This is in sharp contrast to bank overdrafts, which require regular re-negotiation and arrangement fees. 

What are the criteria for factoring?

Factors' requirements vary from company to company. Some will consider start-ups but typically the company must be operating on a business to business basis and have a turnover of £50,000.00 or higher.

Small business factoring

Small business factoring is often the ideal solution for small businesses that don't have a dedicated credit controller and need access to flexible funding options that go beyond the level of finance that would be available from a traditional overdraft.

Access Credit Management can introduce you to a factor that specializes in helping smaller businesses or even start-up businesses. There are no minimum size criteria and annual services charges can start from as little as £2,000. We can also introduce you to lenders that can provide you with a loan via the Small Firms Loan Guarantee Scheme.

Is Factoring or Invoice Discounting Suitable for my Business?

The most suitable candidates for factoring and invoice discounting are growing businesses because the level of funding grows proportionately as turnover increases. However, if you are using traditional loan and overdraft facilities which the bank will not increase, then this type of facility will provide a solution for cash flow.

Although this is a relatively low cost way of increasing your cash flow it would be wise to examine the costs of alternative options before entering into an agreement. Also, debt finance providers tend to prefer firms which receive invoices where it is clear that the goods or services have been delivered and where few payment disputes or credit notes have occurred.

A potentially costly mistake which some companies make when arranging a factoring service is picking the first provider they come across. There are so many providers that simply looking on the internet will probably not get you the best deal.

Online Quotations for Factoring

A word of caution

There are many websites that provide online quotations for factoring and invoice discounting facilities. Although these are a useful way of obtaining quick price comparisons, they should be treated with care.

Through our experience of working with customers who have initially used these sites they produce figures which ultimately have no relevance to the final funding proposal or standard of service because of:

  • Amended quotations - Quotations are produced automatically using formulae that are built into the website. Providers use a variety of criteria to calculate the initial payment percentage and often one of the criteria could significantly affect the amount advanced, for example a large number of credit notes raised.
  • The focus on price - One of the benefits of a site that allows you to compare online quotations is that you can compare the price charged by different providers. However, there is a drawback with this approach in that it doesn't focus on the service you will receive or the nuances of how the provider operates.

Whilst price comparison is important, in practice there are subtle differences between the way that different factoring and invoice discounting companies operate and these differences need to be understood. Factoring with one provider may suit one business but not another due to the nature of the product or service provided.

The Advantages and Disadvantages of Factoring and Invoice Discounting

Advantages of factoring and invoice discounting

Making use of an invoice factoring or discounting service can improve your bottom line and offer your company a whole range of benefits, such as:

  • Improved cash flow by releasing up to 85% of funds against the value of outstanding invoices
  • It gives you access to an ongoing supply of cash that grows as your sales grow
  • In the case of factoring, you work with a dedicated team of professionals who will prepare and send out statements, telephone all of your customers, collect payments for you and maintain professional and detailed accounts of your transactions
  • Management time is freed to drive the business forward as you are no-longer spending time on unpaid accounts and are no-longer held back by insufficient cash flow
  • By making use of a factoring facility you can benefit from improved profitability as you can pay suppliers earlier, buy in larger quantities and take advantage of any volume discounts available
  • Knowing exactly when you are going to be paid assists with financial planning
  • You may find that some customers respect factors and pay their debts more promptly
  • It is possible to protect your company from bad debts if you decide to choose non-recourse factoring
  • You receive cash as soon as orders are invoiced which gives you the option of using it for capital investment and to fund future orders
  • The facility provides flexibility for the business and access to a range of additional products such as cash flow loans, trade or transactional finance.

Disadvantages of factoring and invoice discounting

  • The factor will want to set credit limits for customers which may affect the way you trade
  • Exiting the agreement can be difficult
  • Disputed invoices must be dealt with quickly to avoid them being re-coursed
  • In the case of factoring, you are reliant on the factor to collect the debt in a timely and efficient manner

Recourse and Non-recourse Factoring Facilities

When you make use of an invoice factoring company it is very important to be aware of who is responsible for debts which occur when customers fail to pay.

If you have a recourse factoring facility then the factor will not take the risk of the debt on, they will just collect the money from you if an invoice goes unpaid.

Recourse factoring facilities explained

This is a lower cost form of factoring because you continue to take the risk of bad debt rather than the factoring company. This type of factoring is also easier to attain, the invoice factor will tend to have less stringent rules about your business systems and the payment history of your customers.

Once the invoice is returned to you, you are responsible for collection. If you are unable to do this then you can contact us and make use of our recourse collection service (see UK commercial debt recovery and international debt collection). 

Non-recourse factoring facilities explained

With non-recourse factoring the factor assumes responsibility for all bad debts. This means that if a customer does not pay an invoice, either through insolvency or protracted default, you do not have to pay back the amount advanced to you by the factor.

The factor legally takes ownership of the debt and as a result this type of facility attracts higher fees as the factor is increasing their level of risk.

Non-recourse factoring facilities are difficult to obtain if you have weak financial systems or numerous customers with bad payment histories as strict credit limits will be set for your customers.

It is important to choose the correct type of factoring for the current state of your business, but equally important is choosing the right invoice factoring company to deal with. There are some factors in the market who offer lower levels of customer service, even if they charge low fees this lack of service could end up costing you more in the long run.

Bad Debt / Credit Insurance Protection

Bad debt protection can be provided independently (on a stand-alone basis) or in addition to either factoring, invoice discounting or export finance.

In some cases funding is linked to credit limits but we can introduce you to providers where that is not the case.

If you don't want finance or collections support, we can introduce you to a specialist organization that can provide you with credit insurance against bad debts. Commercial trade credit insurance can be provided against all of your sales, on a whole turnover basis, or against specific customers. It can also be provided on a catastrophe basis so that you are only covered against significant losses. If you would prefer 100% cover we are equally able to assist you. See credit insurance for details.

Export Factoring / Discounting Facilities

Most invoice factoring and discounting companies now offer export factoring and discounting finance facilities.

The main differences associated with export factoring are:

  1. The fees tend to be slightly higher
  2. A minimum annual turnover of £100,000 is normally required but this can also include domestic sales
  3. Currency movements can affect profit margins and it is prudent to use currency hedging to minimize risk
  4. Credit insurance protection is often required to reduce the risk of bad debt
  5. When shipping goods it is necessary to calculate accurately the number of funding days required and agree them with the invoice factor or discounter. Typically invoices are funded for a maximum of between 60 to 90 days, however from the point of dispatch to arrival with your customer may take 90 days. The customer then pays 30 days from the date of arrival so actual funding required would be 120 days to avoid re coursed invoices impacting on your availability and cash flow.

If you are importing goods we can also introduce you to trade finance specialists that can provide trade finance facilities that will assist you with documentation (for example letters of credit and bills of exchange) in addition to finance for your imports. 

Single debtor factoring, single invoice factoring & transactional finance

Businesses can sometimes require finance from a factoring company against a single customer (single debtor or prime debtor). This may be due to a prime debtor concentration of trade into a single customer, or seasonal trading peaks, or you may just want finance against one customer for a specific project without giving the factor your whole sales ledger.

We are able to introduce you to companies that can provide finance against single debtors (prime debtors) or even single invoices to improve your cash flow.

Trade Finance

We can help you raise finance in respect of goods that you are importing from suppliers abroad or, in respect of export sales, to customers that are based abroad (Export Finance). We can even help with cross-border transactions where the goods move from one foreign territory to another.

This type of facility enables you to pay your suppliers on time whilst receiving extended credit terms.

We have access to specialist trade financing companies that are experienced in all aspects of international trade such as letters of credit, bills of exchange and import documentation. We can introduce you to a trade finance provider that is suitable for your business. The cost of trade finance facilities depends very much upon your requirements and circumstances.

Invoice Factoring / Discounting Funding Terms

What does it cost? Understanding the charging structure

  1. The Service Charge & Minimum Annual Service Charge

    The service charge, administration charge or credit management fee as it sometimes called will usually be a percentage of the value of the invoices that are funded. This is an ongoing fee and in the case of factoring provides you with the facility and a credit management service. In the case of invoice discounting this provides the finance facility and the cost of the monitoring/auditing.

    There is normally a minimum service charge quoted which is either charged monthly, quarterly or annually and is calculated on turnover. This provides the factor with the minimum income they expect from the facility and serves to protect them in the event that their client's turnover falls short of the expected financial projections.

    Typical factoring fees range from 0.75% to 2.5% of total turnover whereas invoice discounting fees range from 0.2% to 0.5% of turnover which are significantly less but remember only finance is being provided.

  2. The Interest or Discount Charge

    The interest or discount charge works in a similar way to an interest calculation and is based on the funds in use. This charge is calculated at an agreed margin and typically ranges between 1.5% and 3% over bank base rate.

  3. Other Charges

    There may be other charges which may or may not be explicitly stated within the quotation - it is prudent to question the factor about these. These charges could include:

    • A re-factoring charge (an additional charge on debts reaching a certain age)
    • Charges in respect of electronic transfers or returned (bounced) cheques
    • "Trust Account" charges applied to the transactional activity of your invoice finance account
    • Small additional charges for credit insurance are also made if non-recourse factoring is used. These will range from 0.5% to 2% of turnover depending on the level of risk the factor assigns the arrangement
    • Arrangement Fee or Commitment Fee. There may be an arrangement fee or commitment fee. Normally, an arrangement fee refers to a one off fee that is paid and not refunded whilst a commitment fee may be refunded after commencement. You should question the factor about the exact nature of such fees.

Understanding the funding proposition for invoice factoring or discounting

Calculation of availability

On commencement of an invoice factoring or discounting agreement the finance provider will make available an early payment or prepayment percentage of your agreed outstanding sales ledger which provides the initial cash injection on day one.

From that point onward you simply notify the value of the sales invoices that you have raised each day, week or month. Based on the invoice values and cash received, the factor will create available finance for you to use as you required.

It is not uncommon as the facility develops to be notified by the factor that certain invoices are "unapproved" for funding. These "unapproved invoices" will affect the actual level of funding that you are able to access and may include invoices still outstanding after 90 days or invoices raised in advance of delivery. It is essential to question the factor about how they calculate the available level of funding and understand the implications for your business.

In addition to the above, the invoice factoring or discounting facility may be subject to a restriction against major debtors (prime debtor restriction or concentration reserve) or there may be individual funding limits imposed in respect of each debtor, or credit limits if your facility is non recourse (meaning it includes bad debt protection).

If your agreement is for recourse factoring, there will be a recourse period after which funding is withdrawn. If it is non recourse, there will be a period after which the factoring company will pay the balance of any covered debt to you under the terms of the bad debt protection that they are providing (note for further detail on recourse and non-recourse factoring you can click here.

The invoice factoring or discounting funding terms may also state the maximum value of the facility often known as a 'payment ceiling' or 'refer limit'. This is the maximum level of liability to the factor that you may reach at any time. Bear in mind that this is only the maximum ceiling and does not reflect the level of funding that you can expect to receive.

Security Required by an Invoice Factor or Discounter

The main security that an invoice factor or discounter has is based on the trade debtors of the business which are assigned under the terms of the financing agreement.

However, it is also common for secondary security to be supplied in the form of director's warranties/guarantees.

Director's unsupported personal guarantees are occasionally requested to support the agreement. 'Unsupported' being a personal assurance to the value of £ X and not the charging of specific personal assets.

It is often the misconception of directors that where personal guarantees are provided this is merely to assure assistance to the factor/discounter in collecting in debts should the company cease to trade. Whilst this guarantee certainly gives the factor the leverage to ask this of the directors and is a significant motivating factor in their request of these assurances, it should be very clear that a personal guarantee will give personal liability against the funds borrowed. Whilst the factor/discounter will seek to collect monies in from debtors firstly they are fully entitled to approach the directors for all or any of the amounts remaining outstanding.

Some factors will request director's warranties. These do provide director liability, although only in certain circumstances detailed in the respective document. These often relate to circumstances where fraudulent notification of invoices etc has occurred or cash has been misappropriated. As such these are occasionally referred to as fraud warranties.

If you are unsure about the extent of your liability consult your solicitor before signing anything that provides any personal warranty or guarantee.