Invoice financing is an increasingly popular form of funding. It has to some extent been associated with distressed businesses, although it can also be a good way of funding growing businesses.
What is invoice finance?
In broad terms the funder provides finance at an agreed percentage of outstanding customer balances. Typically a proportion of the invoice value can be advanced as cash the day after the invoice is raised instead of waiting until the customer pays. In some situations funding can be as much as 85% of the invoice value.
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 | 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. |
Invoice discounting with recourse is popular it should involve the lowest charges! What are the practical matters that arise?
Avoid a false sense of security – don’t spend it all at once!
Invoice finance is a loan linked to the amount your customers owe you. A big sales month would result in a higher amounts owed and therefore more funding available. A loan has to be repaid and conversely a low a sales month will mean there is less funding available. If this is not understood and managed there is a risk that there could be a false sense of security and the business could run out of cash.
Invoice finance is not a magic pill
Whilst it may fund invoices before the customer pays, the money still needs to be collected from the customer. Where funding is with recourse, if an invoice has remained outstanding for (as an example) 90 days it is no longer eligible for financing and the funding received must be returned.
Be clear on what is being financed (disallowances)
The amount of funding will depend on the perceived creditworthiness of your customers, whilst a percentage of invoice value is agreed as being eligible for funding, there may be exceptions or lower percentages in relation to particular customers. In addition issues such rebates to customers may lead the funder to disallow part of the headline funding available. The amount of funding you actually receive can be much less that the headline percentage!
Be aware of the extra bookkeeping
The amount of invoice financing will change on a daily basis and in the same way that it is important to agree the company’s bank account records to bank statements, the company’s record of the invoice finance needs to be agreed to the funder’s records.
Cash forecasting considerations
The cash flow pattern of the business will change and this needs to be reflected in forecasts. Where funds are tight the impact of a good sales month (with high funding) followed by a poor one (with low cash funding) can be quite marked.
The disallowances (see above) will change and this also needs to be taken into consideration (as do long outstanding invoices which become ineligible for funding). If you are relying on using all the available finance then any unexpected changes in disallowed amounts could lead to a shortage of funds.
In conclusion, invoice discounting with recourse can be an effective form of funding, particularly for growing businesses. It does however bring with it a number of practical issues that should be addressed. Whilst it may help alleviate cash flow issues, the need for strong cash management and credit control remains an imperative.
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.
