For many businesses, invoice finance is the modus operandi which regulates cash flow. With overdrafts being restricted or closed down entirely, an invoice finance facility gives business owners a flexible funding system, allowing them to draw down on invoices raised without having to wait 30, 60 or even 90 days for them to be paid.
As a company’s invoices are the easiest asset for a funder to collect in the event of default, it is a relatively low cost way of raising working capital. However, an invoice finance offer can at first glance appear as complicated as a detailed explanation of the internal combustion engine.
Here I will try to break down the different terms which make up an invoice finance offer, to help you as a business owner understand the true cost of invoice finance, enable you to see which factors are important for you and ultimately save you some serious money. Ask yourself three key questions:
- How much do you want to borrow?
This is the first thing to consider. The funder will put a value on the facility size based on annual turnover, outstanding sales ledger and the credit profile of the business. This figure will be the maximum amount you can borrow at any given time.
The other factor that will limit the amount you can borrow is the loan to value or advance. If your business activity is deemed riskier or there is a chance your customers won’t pay, you may only be able to borrow a smaller percentage of the invoice raised. This can be affected by the product/ service you provide, the quality of your processes and the credit profile of your customers.
It can also be affected by concentration. If you have a large spread of clients, there is a lower risk of major default than if all of your orders come from one or two accounts. The funder may put a limit on how much of your business can be funded with any individual customer.
The key thing to bear in mind here is that whilst a 70% advance releases less cash than a 90% advance, this may be plenty of funding to enable you to continue trading and the less you borrow, the less interest you will pay.
- How much will it cost?
Once you have established how much you can borrow, the next thing to work out is how much it will cost you. There are a number of different costs associated with invoice finance, the following should outline most if not all, however some providers may use a different name and specialist facilities may have extra fees or different insurance requirements.
The largest cost to consider is the discount rate. This is another word for the interest charged on the money you borrow. Although this is the main cost associated, if you are paid quickly by your customers it will reduce the length of borrowing and therefore the interest paid.
The second main cost is the service fee. This is basically the money that pays for the back office and support you receive from the funder. The two elements to look for here are the % fee and the monthly minimum. A funder may entice you with a low % fee but impose high minimums. On the other hand, if you consistently use your facility above the minimum level anyway, it becomes irrelevant.
Next, you may be charged an arrangement fee. This is the cost for the funder to set you up on their system. Although it is a one off cost, you may have to pay it every time you renew your facility in what is called a renewal fee.
It is likely that you will need insurance against your customers defaulting, called bad debt protection. Whilst the funder may insist that you take this insurance out, it doesn’t have to be with them, so you may save money by shopping around and using an independent insurer.
The final costs you may incur are banking charges. Your funder will open a separate bank account that you both have access to. Depending on whether you use a high street funder or an independent, there may be a fee for the account. You may also be charged a small fee for each CHAPS transfer (although this all adds up), BACS can generally be used free of charge.
This part of the quote is purely a numbers game and edging half a percent off here and there can make a real difference. To make sure that what you are being offered will work as you expect, the funder should be able to provide a demonstration of costs based on you turnover and projections.
- How do the commercial terms work?
The final (and probably most important) part of an invoice finance quote are the commercial terms. This is the nitty gritty of the contract which is easily ignored (and difficult to understand) but will ultimately decide whether your invoice finance facility does what you need it to.
You have to consider the contract length. On one hand you may be able to secure a better deal by signing a 12 month contract, however if you want flexibility to leave when you want, a shorter contract (even 0 month) may be more suitable. Look out also for the renewal fee here; you may end up paying it every 6 months if that is your contract length. There will also be a notice period to close your facility. Depending on when this is triggered you may need to add a few more months on to the contract length
Also important is the funding period, or how long you can borrow the money for. The aim is to match this to your customer payment terms with a small grace period to allow for slow payers. If you exceed the funding period you will have to re-factor the debt, which can end up being expensive. The re-factoring cost is another thing to look out for, especially if you expect some of your invoices to take a long time to be settled.
Most important in terms of commerciality are the back office, support and account manager you are working with. Meeting this person and receiving training on their systems are all part of agreeing a facility and you need to make sure that it is a system you can work with.
If you’ve made it this far, give yourself a pat on the back!
The one thing that is clear is that it is difficult to truly understand an invoice finance facility until you have started using it and probably incurred some unexpected costs.
Start Point Finance have experience in finding businesses the best invoice finance deal available, whether it is a new account or you are considering a change of provider. We can review a quote and lay out, in simple terms, how it will work for your business, hopefully saving you the hassle of finding a problem the hard way.
There is no cost for us to look at the options available and in most cases we can save you a decent percentage of your turnover.
If you would like to save money on your invoice finance, email toby@startpointfinance.co.uk.
If you would like to share your experience of invoice finance – good or bad – or you have anything to add, let me know in the comments below.