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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.

Why Use an Invoice Factoring Broker?

Businesses looking for a suitable invoice finance company can obviously try accessing lenders directly via a telephone directory or through a simple internet search. Alternatively they could look for recommendations from accountants, bank managers or business suppliers.

For businesses who are the identical ‘blue print’ of what the invoice factoring lenders are looking for this can work and the business will be able to source a facility. The questions could be posed, is it the right facility and will it do what the business is expecting?

The problem is that most invoice factoring companies are sales focussed and as such will claim to have the best suited solution and be the most suitable provider. On top of this there are so many variables for a business to consider which can make the decision of choosing a provider very confusing.

In essence, by using a broker it should make life easier. A good reputable broker will have relationships with most if not all lenders in the market. They should have a good idea of the capabilities and criteria of each of these lenders and as such can decide which lenders are best to approach. This will save you time as you won’t be approaching lenders who are not interested based on the size, sector or geography of your business.

A good broker will always start by gaining an understanding of your business. After all, if they don’t understand what you do how can they know which invoice factoring companies will want to help you? They should also understand what exactly you are looking for – in an ideal world what is it that you want? From there they should be able to establish what product will best meet your needs and which lenders are best placed to provide it to you.

By collating the required information and submitting a full and honest report about your business and requirements a broker can quickly establish which lenders have an appetite to assist. If required they can also establish indicative terms. It should be said however, that indicative terms are exactly that until any lender has conducted a meeting and potentially a survey of your business. Only then can they make a credit backed offer where terms can be fully relied upon.

By using a broker to communicate with several lenders prior to meeting them it should mean that only lenders with a genuine appetite to help you will be introduced. This should save you both time and effort.

It is important to remember that headline rates can be misleading and as such a reputable broker should be able to clarify the total costs involved, the amount of cash that can be expected to be generated and of course the obligations of the directors in terms of conduct and security requirements.

The role of a broker should be to provide you with options and to explain those options to you both in terms of benefits, costs and risks. From there you should be able to make an informed decision as to which option is best for your business.
By using a reputable broker you should achieve saving in time and effort, you should achieve savings by sourcing a competitive facility and you should fully understand what you are entering into and the associated risks.

So what should you be looking for when choosing a broker?

Industry experience is obviously key and that means the industry experience of the person who is helping you rather than the person who founded the business. When dealing with some of the larger brokers you could be just dealing with a telesales person who will simply forward your name and number to several lenders in the hope that one of them could help you. Ideally you want to be speaking with a senior person who has worked within the industry and understand the market at large.

Independence is also a major factor. Some so called brokers are nothing more than agents or ‘packagers’ for a particular lender. They will always offer this lender first refusal on any enquiry they receive. Typically for this they will receive increased commissions. A reputable broker will use the whole market to your advantage. They will look at the market to source you the most suitable and competitive invoice factoring facility from the most suitable invoice factoring company.

A good understanding of your business and requirements is also important. He they dealt with similar businesses? Do they understand the challenges you are facing? If they do not give you comfort then it may be best to move on to another broker who can give you confidence.

You should be testing the broker’s knowledge and asking questions. Explain what it is that you are looking for and what you want to achieve. A knowledgeable broker will be able to explain what facilities could be sourced for you and how they will meet your needs.

If you are unsure ask to speak to an existing client who operates in a similar sector to yourself and find out what value the broker added to the process.

Where can you find a broker?

In a similar way to finding a lender you could seek recommendations, look in a telephone directory or do a search on the internet. While invoice finance brokers are not regulated in the same way as say an IFA there are organisations that look to promote the industry at large. The National Association of Commercial Finance Brokers (NACFB) publishes a list of members on their website that can be searched for by postcode.

The perception of invoice finance has changed from being the ‘lender of last resort’ to being a flexible and accessible form of working capital for growing businesses.

Over the years the invoice finance industry has changed its own methods internally to become more user-friendly and acceptable. It has embraced online technology to provide a user friendly interface between the lender and the client. These systems differ from lender to lender but they can allow real time uploading of invoices directly from account packages and they can provide in depth reports about such things as debt turn, specific customer reports and the discounts offered. This more accurate and timely monitoring has allowed lenders to monitor risk more closely and has reduced the perceived risk. This is good news for clients of any invoice factoring company as it has driven down costs and increased the prepayments lenders are now willing to offer. These days we often see lenders offering finance at up to 90% of invoice value and recently I saw a client on 95% prepayment with a bank provider.

Credit control techniques have also been developed that use a mixture of computer generated letters and statements alongside the human touch via telephone calls. These techniques are often a vast improvement on the often ad hoc activities employed by a busy business owner. That said the industry at large accepts that not all business owners want to outsource the credit management function of their business as they want to retain control. The truth is that the closer a lender is to a businesses customers the lower the risk is in providing an invoice finance solution. Beyond the traditional facilities of invoice factoring and invoice discounting the industry have developed various products that can meet the requirements of clients yet still mitigate the risks the lender worries about.

The lack of availability of traditional overdraft facilities over the last decade has also bolstered the numbers of invoice finance users in the UK. This is partly due to what is often referred to as the ‘Brumark Case’ where it was deemed banks are not secure against the book debts of a company unless they have taken an active interest in them. This meant that the security of a traditional all-asset debenture was in question and banks forced clients to offer additional security or to move onto an invoice finance facility to replace the overdraft. This perhaps resulted in many businesses being ‘unwilling brides’ in accepting the facilities of invoice factoring companies it did raise the profile of the invoice finance industry at large and did change the perception somewhat.

More recently with the ever publicised ‘credit crunch’ in full effect the banks were not actively lending in traditional formats, many an asset finance company closed it’s doors and the commercial mortgage companies vanished. In stark contrast the invoice finance market remained very active and in particular the independent invoice finance companies. It is true that there were difficulties in providing the credit limits businesses required on their customers but the appetite to lend against good quality book debts remained firmly in place.

Credit terms have become the norm and any ‘small to medium’ business hoping to supply a ‘high street chain’ or a major supermarket are bound by their agreements and standard payment terms. In contrast they are unlikely to enjoy the same terms with their suppliers who will need paying along with wages and other overheads. The end result for most businesses is a stretch on cashflow and as a result an invoice finance facility is a necessity rather than a choice for many businesses. Large businesses are now used to seeing assignment notices on the invoices they receive and will certainly not frown upon the fact a supplier is using invoice finance. Knowing there suppliers have a suitable facility in place to smooth cashflow and fund growth probably gives them comfort.

There are of course still a lot of businesses that turn to the invoice finance companies as the last resort to breathe some life back into their businesses. Some of these businesses really are on their last legs and while the injection of cash can buy them time it is up to the business owners to make the required changes to save the business. If this does not occur then they are simply delaying the inevitable.

There are now circa 50,000 businesses in the UK that use some form of invoice finance. It is a type of finance promoted by both the Federation of Small Business and the British Chamber of Commerce. Large businesses are comfortable with the fact their suppliers use invoice factoring or invoice discounting. Banks are actively encouraging to take up invoice finance wherever it is a genuine option. This type of finance has become more accessible and also more acceptable as a form of finance for successful businesses.

When looking for a new invoice factoring or invoice discounting facility it is important to understand how the offers you receive compare and also how firm those terms are.

You should look to compare how much cash the facilities can generate given the parameters of your business, what the total costs involved are, what services are offered and what your obligations are in terms of administration and security.

Here are a few tips on how to view the offers and also how to compare offers from invoice factoring companies.

1. Indicative offers are merely an indication. Depending on how in depth your meeting was with the invoice factoring company that provided them indicative terms can often no be a true reflection of what you are finally offered. Some lenders even call these ‘Formal Offers’ which can be very misleading so be careful. Until you have actually had a pre lend survey and the file has been submitted to underwriters it is unlikely you will have what is called a ‘Credit Backed Offer’. Until a credit backed offer is issued by an invoice finance company terms can change dramatically. That makes it difficult to meaningfully compare indicative terms.
2. Ensure that you are comparing like for like when looking at pricing – that means understanding exactly what services are being offered. A facility that includes credit protection and a full credit management service will typically cost more than a facility that offers just finance. The question is which best suits your business and which offers best value for the service provided. You need to look at what it is that you want and then look at what is available in the market to see what the best fit is.
3. Understand what the costs involved are and remember to look beyond the headline rates. Headline rates can be misleading and can make a facility appear cheap in comparison to competitors. With any invoice finance facility it is important understand the total costs involved are – it is advisable to do a comparison based on total costs over a 12 month period including set up fees, service fee, discounting fee, bank transfers, audit fees and don’t forget to check your minimum base rate.
4. What security is required from you and your fellow partners/directors? It is important to understand what security you are offering and when this can be called upon. This can differ from lender to lender and it is important to check.
5. What is the contract period and notice period required by the lender? Traditionally lenders used a 12 month contract with 3 months notice but these days it is not uncommon to see contract periods ranging from 28 days to 3 years and notice periods of a month through to six months. If you are being tied in for a long time you should look for more competitive pricing and service level guarantees. Remember once you are tied in it is very hard (or expensive) to terminate the contract early.
6. What credit limits are available for your customers? It is important to check at least your top debtors to ensure that the invoice factoring lender can generate the cash you expect. Remember that the prepayment level they quote is against eligible debts and that means debts within the credit limits given to each one of your customers. Again this is worth comparing early on in the process as it can severely impact on the viability of any invoice factoring facility.
7. Are there any other restrictions on the facility that will impact on the cash generated. For example, what is the concentration limits that restricts the amount of funds generated against your largest customer, what is the cap on exports, what is the total facility limit – is that sufficient, can they accommodate your growth plans?
8. What are the requirements of you from an administration perspective? Some lenders have a fully automated system that links with your accounts package meaning as soon as you upload invoices the cash is available. This means there is no additional work involved in running an invoice finance facility. In comparison some lenders require notification of each invoice manually along with a copy Proof of Delivery. This can be mundane and time consuming so it is important to understand what is required of you to operate the facility.

Comparing invoice factoring quotes can be a time consuming and confusing exercise and it can often be worth using the services of a reputable invoice finance broker or your accountant to look at them impartially. You bank manager will also look to advise on this but please remember they can only really recommend the services of their own bank so they will be somewhat biased.

Reputable invoice finance providers are regulated by the Asset Based Finance Association (ABFA) but please remember the same facility from different lenders can be very different.

Welcome to the Invoice Factoring Forum and Blog.

This is a discussion board for anything related to the invoice factoring industry. As the industry changes as some lenders leave the market and new ones arrive, new products are developed or we come across matters of interest we will keep you updated.

We welcome opinions but where possible please keep them constructive with the view of helping people gain an insight into the industry and more specifically into this form of finance. So if you work within the invoice finance industry, are an existing user of invoice finance or you are considering using an invoice factoring company we would welcome your views, details of your experiences or questions.

Keep checking in to see what has changed!!

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.