Benefits and pitfalls of invoice discounting

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Invoice finance is an increasingly popular form of funding. To some extent it’s been associated with distressed businesses, but it can also be a good way of funding growth.

What is invoice finance?

In broad terms the funder provides finance up to an agreed percentage of outstanding customer balances. Typically cash can be advanced the day after an invoice is raised instead of waiting until the customer pays. In some situations funding can be as much as 85% of the invoice value.

This article focuses on “invoice discounting with recourse”, there’s a jargon section at the end of this article, but it’s the type of invoice finance that should attract the lowest charges.

What about the practicalities?

Look beyond the headline

The amount of funding you effectively receive can be less than the headline percentage. That’s because of “disallowances”; here are some examples:

  • A lower percentage or even no funds may be advanced for sales to particular customers, this would be where the funder has concerns about creditworthiness.
  • Some funding may be reduced where individual customer balances or a group of similar customers’ balances represent (in the funder’s mind) too high a proportion of the total amount owed by customers. An example could be where there is a very high level of export receivables.
  • Rebates to customers may also lead to a reduction to the headline funding.

Different funders will provide different options, the best headline may not always be the best deal for your business!

Invoice discounting isn’t a magic pill

While money comes in before before the customer pays, the money still needs to be collected. If an invoice is outstanding for a long time (say 90 days) it will become ineligible for financing and the funds must then be returned.

There will be extra bookkeeping

The amount of invoice financing will change on a daily basis and in the same way that it’s important to agree the company’s record of bank transactions to statements, the books also need to be agreed to the funder’s records.

Cash forecasting considerations

The cash flow pattern will change. High sales lead to more funds being available immediately, while related supplies and wages may need to be paid later.  If cash flow is tight, falling sales can be problematic.

The impact of future disallowances and long outstanding invoices will need to be considered. Unexpected changes can lead to a shortage of funds particularly if you are using all of the available invoice finance.

Wrapping up

Invoice discounting can be an effective form of funding, particularly for growing businesses. It does however bring with it a number of practical issues that need to be considered. While it may help cash flow, the need for strong cash management and credit control remains an imperative and the administrative implications should not be underestimated.

If you are considering invoice discounting and would like to discuss this further then please contact me, David Lewis, on 020 3137 2279 or e-mail mail@camroseconsulting.co.uk.

and….the jargon

Invoice financing may take the form of:

  • Factoring: Customer collections are outsourced to the funder and the customer will be aware that the company is receiving this type of finance.
  • Confidential invoice discounting: The company continues to collect money from the customers and the funding arrangement is not disclosed to the customer.

Funding may be on a recourse or non recourse basis, the differences are:

  • Recourse: The company takes the risk of non payment. Once an invoice has remained outstanding for (as an example) 90 days, it is no longer eligible for financing, and the related funding must be returned.
  • Non recourse: The funder will bear the risk of non payment.

 

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