Many businesses struggle with obtaining payment of their invoices at this time of year. Maintaining cash flow is an important part of ensuring the successful management and trading of many SMEs.
At Stephensons we have a range of services available to assist businesses who are struggling with cash flow. In addition to the services that Stephensons provide, Stephensons are also able to advise upon many other options that are available within the finance industry.
Over the next few weeks, we shall be exploring each of these options and with number of articles that explain the options available.
The first article will be on invoice finance, which is a very popular way of improving and managing cash flow.
What is invoice finance?
Many businesses, ranging from limited companies to sole traders and partnerships, manage their cash flow by different types of invoice finance. Invoice finance is a “catchall” term used to describe the various finance facilities available where cash can be released from invoices in order to assist businesses with their day-to-day cash flow requirements. Usually, invoice financiers pay between 60 to 90% of the value of the invoice, although higher percentages can be paid in certain circumstances.
What different types of invoice finance are available?
Factoring
This is the most common type of invoice finance. It is ideal for new start up businesses and businesses without a robust credit control department, but it can also be tailored to more established businesses. Up to 90% of the value of invoices can be released in certain circumstances.
The service is accompanied by a full credit control system provided by the invoice financier. The system operates as follows
- The business invoices the customer for goods or services rendered
- The business sends this invoice to the financier (usually online)
- The financier deducts a service fee which is usually a percentage of the invoice. This fee is always borne by the business and cannot recovered as part of the invoice
- The invoice financier gives the business up to 90% of the invoice value
- The invoice financier carries out the credit control or the business may chase payment themselves
- The customer pays the full amount of the invoice to the invoice financier
- The invoice financier gives the client the remaining 10% (or whatever the balance of the part payment is)
Factoring is disclosed to the businesses’ customers and provides more protection for the invoice financier.
Factoring is good for:
- New start up businesses which may not be able to obtain credit facilities elsewhere for a reasonable fee;
- Businesses that do not operate a robust internal credit control department or cannot justify the cost of a credit control function – Factoring will generally be cheaper than employing a full time credit controller
Confidential factoring
This works on the same principle as factoring but is confidential and the businesses’ customers do not know the invoice has been factored. The business sets up a factoring service whereby the invoice financier will pay out a percentage of the client’s invoices immediately once the invoices have been raised and sent to the financier. The usual percentage is between 60 to 90%. All credit control and sales ledger management services are operated by the invoice financier on a confidential basis but in the name of the business.
Confidential factoring is good for most businesses, but mainly those who deal with customers who do not allow their invoices to be factored or where confidentiality is a real issue. The business will also benefit from a proven credit control team managing their sales ledger. This in turn should bring average debtor days down.
Invoice discounting
This is perceived to be the most popular type of invoice finance service provided. The business handles their own credit control and maintains their own relationship with the customer. It allows the business to release funds tied up in outstanding customer invoices quickly and professionally. The invoice financier simply provides the funds to assist the business.
The facility can be operated on a confidential or disclosed basis. Disclosed means that the invoice financiers’ details are noted on the invoice. Confidential means that the invoice financier’s details are not contained on the invoice.
If the facility is disclosed, certain invoice financiers may be prepared to offer finance on more unstable debts and in industry sectors not recognised as being stable.
The funding level can increase alongside the client’s own business growth. Bad debt protection/credit insurance can also be provided alongside the service.
Whether a business is suitable for this type of finance will be subject to the quality of the debt, the financial performance of the business and the management of the business.
Invoice discounting is good for businesses that are able to collect in and manage their own debts
Funding contractual debt
Some invoices are based upon contractual debts. This means that invoices are raised based upon a contract between a business and it’s customer. For example, a business may supply goods to a supermarket and the contract contains clauses that may impact upon the debt. This is a difficult service for invoice financiers to provide as it is often awkward to fund due to the terms of the contracts. For example there may be termination clauses in the event of late delivery or quality issues which will affect recoverability of the invoices. There may also be various damages clauses.
Despite this, some invoice financiers will consider funding contractual debts.
Export factoring
This type of service is aimed at UK based businesses who trade overseas. It can be businesses where export is up 100% of the total book debt or businesses where the book debt is split between UK and overseas. It works on the same basis as normal factoring and allows cash to be released on outstanding invoices.
Most invoice financiers who offer this type of service will allow funds to be advanced in pounds, euros or US dollars. Quite a few of the invoice financiers will also collect in currency and have partnerships with the local banks. There may also be an option to run the ledger on a confidential basis.
Revolving finance
The purpose of revolving finance is to target businesses with a small turnover. It is businesses with a simple debt who often want to sell the product to move on. The particular type of business who may be interested in revolving finance does not wish to use invoice finance as the fees may be too disproportionate for their small turnover. It results in agreed funding being made available as and when the business requires it. Fees are usually charged on a daily fee basis once the account is exercised. In essence, it operates similarly to an overdraft, although some invoice financiers may not require the revolving finance to be repaid on demand.
Purchase funding
The purpose of this type of funding is to provide importers and wholesalers with access to funding that they may need in the UK and overseas market.
The funding will pay suppliers of goods by providing up to 100% of the cost of those goods. For example, the business will place an order with their supplier. The invoice from the supply will then be sent to the invoice financier. The invoice financier will provide what is known as a letter of credit with the supplier and the supplier then has the comfort to ship the goods. The business then receives the goods and the business repays the funding together with any charges to the invoice financier.
Recruitment finance
This is similar to invoice factoring but is tailored to a recruitment agency. Many invoice financiers have an online computer-based system whereby the recruitment company can deal with their general management of their business including settlement of invoices online. The difference is that often with recruitment finance up to 100% of invoices can be paid.
Bad debt/Credit Insurance
This is not an invoice finance service in itself, but is a product that can be added to an invoice finance service in order to protect the business from the risk of suffering a bad debt in the event of a customer going into insolvency or the customer’s inability to pay. It is effectively insurance to cover bad debts. It can also enable invoice financiers to make additional funding available if there is a high proportion of debtors to one specific company.
How do I find an invoice financier?
Many invoice financiers operate websites that have details of their products.
There are also many Brokers who have access to various invoice financiers and these Brokers can assist businesses in the first instance with what type of product the business may require and also then recommend the invoice financier. The Brokers may also have access to special deals or rates of invoice financiers.
Businesses are also able to ask their accountants for any advice on invoice finance.
What happens when I locate an invoice financier?
Once the business has found an invoice financer and made contact, a representative will visit the business at no initial cost to the business and see what product would best suit that business.
After this initial visit, an offer letter will be issued giving the business an indication of fees and the various products that the invoice financier recommends. The offer letter is only indicative of the terms and will be subject to a number of terms.
If the offer letter is suitable for the business, the invoice financer will carry out what is known as a survey of the business. This is effectively due diligence for the invoice financier to ensure that the business is suitable for invoice finance. The invoice financier will advise the business in advance what documentation is needed for the survey.
If the invoice financier is satisfied following the survey, the “deal” will be underwritten and is ready to proceed. The invoice financier will then issue one or more of the following documents for signing by the business:
- Debenture over book debts to secure any invoice finance
- Factoring Agreement setting out the terms of the invoice finance
- Personal Guarantee to be given by a director of the business to secure debts. This can be open to negotiation with the invoice financier and in most cases should be limited to a value and not be supported by any personal assets
- Legal Charge over company property if required by the invoice financier to secure debts. Again this can be open to negotiation with the invoice financer
Once the above is agreed and signed, invoice finance can be provided.
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