Cashflow Financing by Factoring and Invoice Discounting
Who Can Use It.
This is a facility which is available to businesses who sell goods and services on credit to other businesses. It is not always open to such businesses in their first year.
The single most important issue which determines whether your businesses cash flows are negative or positive is the lag between invoicing goods or services and getting paid for them. If this is a problem for you then discounting your invoices is without doubt the most effective remedy. There are two principal forms of discounting; factoring and confidential invoice discounting, (CID).
The Difference Between Factoring and Invoice Discounting
Factoring and invoice discounting both operate on the same principles: The discounter advances cash against an agreed percentage of your invoices (including VAT); typically 80% of their value, within 48 hours and as they are settled by your customers you receive the 20% balance. The benefits are that you get the bulk of the cash your invoices represent within 48 hours of raising them, as opposed to waiting weeks or, more likely, months for the money to come in.
Factoring
Factoring differs from straightforward discounting in that your customers don’t pay you; they pay the discounter direct who does the job of collecting and chasing the money, something they do effectively but discreetly.
Confidential Invoice Discounting
Confidential invoice discounting means that you do the job of collecting the cash and remitting it to the discounter; this option is usually only open to larger companies with invoicing of £500,000 + p.a. The fact that you are discounting is not disclosed to your customers, hence ‘confidential’.
What Does It Cost?
You pay a service charge on your invoicing, which varies depending on whether you are factoring or discounting. This applies to all of your invoicing for sales made on credit through your sales ledger. It does not apply to sales made by cash or by credit card. Factoring service charges run from around 1% - 3%, Confidential Invoice Discounting service charges from around 0.5% - 2%.
When factoring you are not bearing the high costs associated with credit control. Whether using factoring or invoice discounting, you save on cheque clearance charges for individual payments from customers; this is included in the service charge. The greatly improved cashflow these services offer a wide variety of benefits such as negotiating better terms from suppliers for early settlement, improving stockholdings, or reducing bank debt etc.
You pay interest on your account with the discounter; typically from 2% - 3% above base rate; roughly in line with the bank. Interest is only payable on the balance between the money you have drawn from the facility less payments received from your customers, which means it operates in exactly the same way as a bank account.
What Security Do They Require?
Invoice Discounters generally look only to your invoicing for their security; this means that personal guarantees from the directors or debentures and other charges on the company are not usually called for. However because this is so, it is crucial that your sales ledger management is faultless; it is after all the discounter’s sole security. Invoices can only be raised once the delivery of goods or services has been made; credit notes which fall due must be issued promptly and any queries or disputes, which are likely to delay payment must be resolved as soon as they may arise.
Invoices That Do Not Qualify for Factoring or Invoice Discounting
Discounters will not countenance paying out on any invoice for goods sold on sale or return or against contracts involving stage payments. They will not factor invoices for any client with a known history of bad debts. Any qualifying debt which has become seriously overdue, e.g. by more than 90 or 120 days, will be deducted from your next availability, so good credit control is very much in your interest.
How Will My Bank React If I Factor or Discount My Invoices?
Banks do not regard unpaid debts from your customers as prime security, nevertheless if you decide to discount the bank may seek to reduce the overdraft limit as your sales ledger will no longer be part of their collateral. Your increased cashflow will more than compensate for this, as ticking the Factoring / Invoice discounting box in the liquidity webchart and picking a lower overdraft will clearly demonstrate.
What To Do With the Money
The inflow of cash which results from invoice discounting may feel like winning the lottery at first, but your approach towards your finances should remain cautious to reap the full benefits of the facility. Increased stock holdings or other such expenditure should be targeted on the best selling and fastest growing lines. Discounting should never be employed to finance extended credit to customers nor should it be used to cover long term commitments or dividends. Where it comes into its own is in financing growth and in enabling you to pursue new opportunities. It is ideal for example in allowing you to undertake purchases where letters of credit are required without crucifying your cashflow. Allowing for a % of purchases by letter of credit, then viewing your liquidity webcharts both with and without invoice discounting being selected will clearly demonstrate this.
It should be remembered that when factoring / discountimg is selected, Figurewizard draws down sufficient funds to maintain your bank overdraft at zero whenever possible, although cash inputs unrelated to sales such as new capital, the injection of short term loans or the proceeds from the sale of assets, may produce temporary positive balances.
This means that funds that are available to you will not be drawn down by the system if your business bank balance is at zero or better. The value of such surplus funds are shown month by month in your detailed cashflow / liquidity reports.
Your ultimate aim should be to utilise the facility until such time as the cashflow generated by retained profits will allow you to develop within your own resources.
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