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Stories Tagged ‘Invoice Discounting’

Invoice discounting v Overdraft facility

This is a question that I am often asked and unfortunately it is a purely academic question for most businesses. Due to certain test cases relating to floating charges banks are no longer comfortable to lend on overdraft where the major asset within a business is the debtor book. On that basis invoice finance is typically the only option available to a business.

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Invoice Finance is the generic terms that describes both the industry and the product that provide finance against invoices that a business raises to other businesses.

Under the umbrella of invoice finance there are various products including:

Invoice Discounting – this is where a finance company will provide finance against the invoices raised by a business but the responsibility of collecting the debts in remains with the business itself. This type of facility can be either disclosed or confidential.

Factoring – this is where an invoice finance company purchases the debt from a business and not only provides finance but also provides the credit control function – i.e. they chase the debts. Disclosed factoring is by far the most common form of finance however confidential factoring can be sourced.

CHOCS – this stands for ‘clients handles own collections’ and operates in the same way as a factoring facility. However, the  factoring company allows the client to do their own credit control.

Beyond this there can be recourse and non-recourse facilities for all these types of facilities.

When choosing your facility it is important to consider what you require from the facility and then it is worth speaking with an invoice finance broker to see what facilities will best meet your needs. It is important to remember that each lender has it’s own criteria and capabilities.

Our client is a haulage company. They approached Smart Factoring Quotes to seek advice on how best to set up an invoice discounting facility. They were keen to obtain a facility that allowed ‘export invoices’ to be raised to their european clients for the backloads that they carried back to the UK.

Our client had been through challenging times because of rising fuel prices and exchange rate fluctuations. However, they had maintained turnover and had a well established business.

They had been offered factoring facilities but felt that they were best placed to collect in the debts as they knew their customers best. As such they wanted an invoice discounting facility.

If you look at the whole market of invoice finance companies not all are able to provide invoice discounting. Our client was raising export invoices which reduced the amount of lenders able to assist even further.

Through our knowledge of each lenders capabilities and criteria we were able to introduce lenders that were genuinely capable of helping and more importantly were actively seeking new clients.

As such we secured a confidential invoice discounting facility for our client at very competitive rates.

Recently I have seen quite a few confidential invoice discounting clients looking for flat service fees. The most recent being a recruitment business with a turnover of £56m. I asked why the flat fee was attractive and was told it “impacted less on margins.” Who am I to argue with someone who has a built up such a large recruitment business and has been a user of invoice discounting for over a decade. I did however feel that it warranted a comment on the forum.

So what are the benefits of a flat monthly fee? Well I guess it is easier to budget and potentially cheaper for a company with a rising turnover but in reality the costs should not differ dramatically to a percentage based fee. The way the flat fee or percentage based fee is calculated will be the same for any lender anyway. Most lenders will arrive at a monetary service fee and then convert it to a percentage of gross turnover anyway.

There is obviously a requirement for flat fees though as one of the ‘new kids on the block’ Gener8 Finance use this as their USP.

Personally I can’t see the advantages but I guess it provides certainty and in times such as these something has to be said for that.

I would however welcome anyones thoughts on this……

Invoice Discounting can often be a difficult facility to source yet many businesses strive for it without considering the alternaitives. Many people feel that the only alternatives are confidential invoice discounting or full factoring where the lender helps collect your invoices and an assignment notice is on each of your invoices.

What are the alternatives? If you are just looking to collect your own invoices and don’t mind disclosure you could look at either a CHOC’s facility (Client Handles Own Collections) or even a Disclosed Invoice Discounting facility. Both offer lenders more comfort in terms of risk as their involvement is disclosed but they offer businesses the control over credit management.

If confidentiality is key some lenders offer confidential factoring. The lender will undertake your credit control they will call up in the name of your business. This offers you the benefit of an outsourced credit control function but with the confidentiality you feel is important.

Finally there is confidential CHOC’s. This offers the benefits of confidential invoice discounting but it offers the lender slightly more comfort. Without getting too technical (and boring) it means the lender is running a mirror ledger at any time meaning their perceived risk is lower.

Interest rates in the form of the Bank of England base rate have remained unchanged at 0.5% for the last 17 months. These low base rates seem attractive to borrowers but are crippling savers who rely on the income their savings generate.

Will rates rise? I think the evidence overwhelmingly suggests that these ultra low rates are not sustainable and as such, yes rates will rise. In a poll of economists by Reuters (29 July) the conclusions were that interest rates would rise from April-June 2011. It was thought that they would rise to 1.5% be the end of 2011.

If you are a factoring client, how will the impact on your costs? Well in some cases it will obviously increase your costs of borrowing money as your discounting fee is made up of a margin and a base rate. As the base rate rises then your costs would increase surely? The answer is maybe. It will differ from lender to lender.

HSBC invoice finance for example have no minimum base rate so any increase from the 0.5% Bank of England base rate will be felt by their clients who are currently enjoying these very low rates.

However, Bibby Financial Services are currently using 3 month LIBOR as a base rate and in the quotations I have seen are using a minimum base rate of 3%. This means that until the base rate (3 month LIBOR in this instance) increases above 3% their clients will not be effected by the potential base increases.

Close Invoice Finance use 1 month LIBOR as a base rate but have an overall minimum discounting fee of 4.5% . So any base rate increases would only impact on the clients of Close Invoice Finance if their total discounting fee increases above 4.5%.

Looking at the invoice finance market in it’s entirety there are a lot of clients who won’t feel the impact of any impending rate increases for some time.

Is this good news? It depends on how you view matters but some may argue that the ones who will not feel the effect of the increases are paying too much at the moment anyway. Then again, you can only choose the best of the offers that are made available to you.

The Hidden Costs of Invoice Factoring

Typically an invoice factoring company will quote two headline rates – service fee and discounting margin. The service fee is quoted as a percentage and is applied to the gross value of each invoice notified. The annual service fee charged by factoring companies is therefore the percentage service fee applied to the gross turnover. The discounting margin is the percentage above the base rate that an invoice factoring company charges for the amount that they have advanced to you. The discounting fee equates to the interest rate that you would pay on an overdraft facility.

Beyond these headline rates are charges that are perhaps not so obvious and can make the comparison of facilities from different lenders quite challenging. These are a few of the charges that you should be asking about:

The base rate and minimum base rate. Some invoice factoring companies will quote over bank base rate while some will quote over 3 month LIBOR. It is important to understand how these differ and how they fluctuate. Some lenders will also have a minimum base rate which when base rates are very low come into effect. It is important to ask what the minimum base rate is as this can have an impact on the amount of discounting fees that you pay as a client.

Minimum service fee. All lenders will implement a minimum service fee and this can be set as a monthly, quarterly or annually paid fee. A major variable in calculating the service fee that you pay is turnover. If your turnover should drop dramatically and the invoice factoring company does not recover the fees they had expected then the minimum fee will kick in.

Audit fees are also charged by some lenders whereas as some other lenders include this as part of the service. If you are comparing costs and a lender is charging £500 a quarter for audit fees then it is important you are aware of this.

CHAPS transfers are transfers that allow you access to your cash on the same day. These costs can be significant as in many cases people will use these on a daily basis. These costs can vary from lender to lender and it is important to take these into account.

Arrangement fees are charged by some lenders and are a type of fee we are seeing creep into the pricing models of more and more lenders. It is important to remember that the service fee you pay is applied to the balance of your ledger when you commence so there is already a sizable fee to pay on day one. The addition of a separate arrangement fee obviously adds to this.

Legal documentation fees are charged by many lenders and again differ from a nominal sum to quite significant amounts. This can be on top of an arrangement fee.

Refactoring fees are charged by some lenders when they recourse invoices back to you as an invoice factoring client. That means that when an unpaid invoice ages beyond the funding period you have agreed with a lender they will pass this invoice back to you and charge you a percentage fee for doing so. This can be frustrating for full factoring clients because they have paid a service fee to a lender to not only provide finance but also the collect in invoices on behalf of the client. In this instance they are actually charging you more for not providing a service you have already paid for. The logic behind it is that it encourages you to get involved and help collect in the debt or at least provide them with information such as a proof of delivery to help the factoring company resolve any query.

To fully understand the list of charges of any individual invoice factoring company it is important to request a list of their disbursements.

In discussing the charges above it is important to remember that invoice factoring can be labour intensive for the invoice factoring company and if they are providing a good service they deserve to be charging a reasonable and fair amount for that service. It also important to understand what you are receiving for your money. In terms of credit control how does the lender you are speaking to go about the credit control? Some lenders will simply send out monthly statements and a series of automated letters and this may work for your debtors. Other lenders will telephone chase every invoice when it falls due and as such are providing a more hands on service and perhaps deserve to charge more for this. The question is what level of service are you looking for as a client?

The costs described above should also be offset against the time that an invoice factoring service frees up for the client. Will this time be focused on sales and growing the business? If so what are the additional benefits? In addition what can be done with the cash generated? Be entrepreneurial – if you now have an additional amount of money in the business what can you do with it? How much more money can you make with it?

The key is to understand what you will be paying for the service that you receive. By understanding all the potential fees you can compare the expected annual costs of each invoice factoring offer you receive. By also understanding what level of service is being provided you ensure you choose the offer that represents the best value to your business.

Cheap Invoice Finance Companies can be found but ‘cheap’ is obviously relative to other invoice finance providers. Invoice Finance will typically nearly always be more expensive than an overdraft facility, however Invoice Finance offers additional benefits such as flexibility. Smart Factoring Quotes do however have a few lenders at present who claim that they will not be beaten on price so why not help us test that theory for the benefit of your business?

Cheap invoice finance companies will offer the overall lowest fee structure once you have considered the service fee, discounting fee (including the base rate, minimum base rate and discounting margin), audit fees, set up fee, legal documentation fee, survey fee, etc, etc.. The list of additional fees from some lenders can be extensive and unfortunately not always transparent or easy to understand.

When selecting an invoice finance facility and provider my advice would be not to just shop on price. In the first instance you need to see which invoice finance providers can offer you a facility that works for your business and it’s unique circumstances. It is pointless taking up an invoice finance facility that will not provide what you need just because it appears cheap. Find which invoice finance providers can offer what you require and then do the price comparison ensuring you look beyond the headline rates and consider total costs. Remember you will typically be tied in for 12 months with an invoice finance facility.