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Service: Insolvencies
Date: 24/04//2013
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Thinking of Invoice Discounting?

With the demise of the good old bank overdraft many SMEs have had to look elsewhere for working capital funding (in simple terms bridging the gap between paying your suppliers and the wages and getting paid by your customers).

Many have turned to invoice discounting to provide that funding, and in certain market places it is very easy to source. But for every business owner who swears by it you’ll find another who’ll swear at its very mention!

So what is invoice discounting, how does it differ from factoring, and what are the pros and cons?

In simple terms

Factoring – individual invoices are purchased by the factor
Invoice discounting – an advance against the ledger as a whole

In each case you pay a fixed fee, based on the value of the invoice and then interest on the time that the debt is outstanding.

Who provides it?

Subsidiaries of the banks (both UK and international) or independents such as Bibby. The latter are the last major unregulated bit of the finance market and are pure commercial beasts. They have wholesale lines of funding from major banks and are effectively retailers, in finance terms.

The collective reference below is “discounters”.

Main Benefits

  • The facility is based on a straight percentage of your invoice (factoring) or total debtor book (discounting) and moves with the level of business activity
  • Levels of advance can be as high as 90% but more likely to be 80%. The balance (less fees) is available when the customer pays 
  • It isn’t dependent on business profitability, so can be suitable for start ups and early stage businesses
  • Generally easy and quick to arrange
  • They have better intelligence on your customers’ paying records than you, because they will typically have a number of clients also dealing with that customer, and have detailed statistics on payment performance. So if they are reluctant to offer a high credit limit on your prize customer it is usually with good reason. Use that intelligence.
  • The basic facility is generally inexpensive – you pay a flat % of your total sales, which is usually less than 1%, but with a minimum charge, and then an interest charge on the amount actually advanced, typically between 1.5% and 3% over bank base rate.  Pricing is very much risk driven.
  • You can price bad debt insurance into the package (under a factoring deal this is known as “non-recourse”)
  • The factor will take responsibility for debt collection, as it has become their debt. The facility price is higher to reflect that service
Traps for young players

  • It is time consuming internally – the accounting reconciliations required by the lender add an extra layer of time and (hidden) cost. You also have to run an extra bank account to bank monies in as they “belong” to the discounter, and provide regular reconciliation reports.
  • There are bank fees if you draw down by CHAPS from non bank lenders, eg Bibby. If you are drawing daily that can really mount up.
  • Audit fees – they will send in their people 2-3 times a year, at your cost.
  • Credit limits on customers are set by the discounters so won’t fund you if you go over those, even if you think it is a good risk.
  • If payments not collected by agreed date you have to refund the advance (so you are still on risk if the customer doesn’t pay). Don’t assume that you can simply claim on the bad debt insurance – that only works in the event of the customer going out of business, not just because you have sloppy credit control!
  • If sales drop then your cash flow is hit immediately.
  • Contracts with discounters are non negotiable - watch the notice periods.
  • Whatever they say at the outset about advancing you 80% of your ledger, you will almost certainly find it is less because they will disallow items over 90 days, items where there the customer is also a supplier, or where any one customer represents more than say 20% of the ledger (concentration).
  • They will fund businesses with clearly defined supplies of goods or services where delivery can be simply confirmed. Things like construction are harder, because of the valuation processes, retentions etc.
  • Discounters will want a limited personal guarantee - this is really an anti fraud warranty rather than a full bank type guarantee.
  • They’ll trim your facility if you have arrears with VAT/PAYE.
  • Generally it won’t cover export sales (some do, but depends on them having a local office to do a credit check and collect a debt if required).
  • You will deal with the sales team, who are all entirely reasonable plausible lovable people (but on commission) and you won’t deal with the administration team until you are signed on. They can be like chalk and cheese. Their job is to ensure they do not lose anything they have advanced to you, and of course, to make money out of you along the way.
  • Also bear in mind that this industry is still largely commission driven and stories of misspelling are rife.
In conclusion

For many businesses, invoice discounting is a simple method of financing working capital. Discounters like suppliers of Printing and Stationery products – there is a simple trail of tangible products, with evidence of delivery and typically a large customer spread and low value invoices, so relatively low bad debt risk.

But before signing anything take advice from someone who has been there, done that. Many of the bad stories are based on naive assumptions about what the service would or would not provide.

By Desmond High BA FCA CF, Director of EMC Management Consultants Limited

About the author

ICSM Credit have worked with Desmond High, a Chartered Accountant with extensive experience of both advising and working in smaller growing businesses, for many years. He has been a director of companies that have taken on invoice discounting and has provided personal guarantees and managed the relationships with the discounters.

He can be contacted on 0844 854 1850, or desmond.high@emcltd.co.uk




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