Fit for funding – About invoice finance

With a range of funding products to explore, is it a good idea to start with the most controversial one?

Most people have a view on invoice finance, often referring to a friend of a friend’s nightmare experience. Fortunately he is conveniently too far away to answer any questions.

So, lets start off with 2 hard facts:

1. A fundamentally flawed business will never become successful because it uses invoice finance.

2. A successful business will never fail because it uses invoice finance.

I’m glad we’ve cleared that up!

What is invoice finance?

Invoice finance is a generic term covering a wide range of facilities whose common theme is that they involve borrowing money against trade debts.

At the extreme ends of the spectrum are:

Confidential Invoice Discounting: A 2 party agreement where the client borrows a percentage of monies due from their customer. The end customer will not know of the arrangement and the lender will have little or no input in the invoicing or collection process.

Non Recourse Factoring: this amounts to a virtual sale of debt to the discounting company. They will run the sales ledger and advance money, whist taking on the full credit risk of the final customer.The end customer will be party to the arrangement.

In between these extremes is a huge range of stopping points allowing you, the client to adjust the input and corresponding costs of almost every facet of the agreement.

Whilst most invoice finance is contractual – working on an all or nothing basis – recent years have seen huge growth inselective or single invoice finance. As the name suggests, this enables you to dip in and out, raising cash against one or more invoices on a strictly ad-hoc basis.

Who qualifies?

The core requirements of invoice finance are:

– B2B debt.
– Defined/quantifiable events (eg delivered goods, signed timesheets, QS sign-off etc).

Beyond that, it is an open field.

What is good about it?

Since overdraft is no longer widely available, invoice finance is becoming the primary source of variable financing – you can dip into the available pot of funding as required and pay for the amount borrowed.

The facility works best in a business with a steady and sustainable level of growth.

Selected wisely, the collections aspect can become a valuable and cost-effective outsourced credit control function.

What is bad about it?

There is a small but persistent perception that on disclosed facilities, customers will take a negative view of factored invoices. It is difficult to quantify this though experience suggests that in many cases the end customer is actually using a similar facility – whether disclosed or otherwise.

A more pervasive problem is that facilities all too often are bought (and sold) in haste relying on the headline rate of interest as a negotiating tool.

Unlike most debt arrangements, invoice finance revolves around a relationship – if you buy badly you will be stuck for the wrong partner. There are many variables in an agreement which include:

  • Borrowing rate – The cost of borrowing against the facility, typically expressed as a rate above base.
  • Factoring charge – A blanket cost for credit management, often expressed as a percentage of turnover.
  • Minimum term – The agreed minimum agreement term before you can give notice.
  • Notice period – the notice you must give – after the minimum term to exit the agreement.
  • Fees – arrangement, minimum monthly charge, and others.
  • Concentration limit – the amount they will lend against any one debtor
And so it goes on – the point being that the rate of interest is actually a relatively minor consideration.
So, should I do it?
Bought wisely, invoice finance can be an invaluable tool for funding growth. However it isn’t a cure for bad business.
Best advice would be to look at your business process and build in the relevant parts of invoice finance – not the other way around.
And never, ever buy on price alone…