Invoice Finance or Factoring is often perceived as an expensive option for a business looking for additional cashflow.  But what are the costs versus the benefits of using an invoice factoring arrangement?

Factoring provides funding against the value of invoices combined with credit control.  Firstly we should define the costs associated with factoring invoices: 

There are 2 elements to the charges:

Funding:

Factoring your invoices normally provides around 80% of the invoice value paid up front with the 20% paid when the customer pays.   So, on a sales ledger of £150,000 there will be available funds of £120,000.  You do not need to take all the funds available and you are only charged on the funds that you do take.

The charge for the funds advance is an interest charge (often called a discount charge) which is a percentage over bank base rate e.g. 2.5% over bank base rate (currently 0.5%) so the total charge is an annual 3% charged on the funds advanced.

Example:

£100,000 borrowed would be charged at £3,000 for the year.
This is very cheap money especially for small businesses that don’t have the clout to negotiate low rates.

Service Charge:

The factoring company will provide you with a service whereby it will chase invoices and collect money on your behalf.   They will also want to charge you for the administration of their facility.

 
This is charged as a percentage of your sales turnover e.g.  1.0%  - so if you have sales of £1m the fee is £10,000.   The charge will depend on the perceived risk of funding your business and the perceived workload of managing your ledger.

So for a company with £1m sales and borrowing £100,000 the annual charge is £13,000.  At first glance this may seem expensive money but is this the case…?  What are the benefits and do they provide pay back for these fees.

Reduce Overheads

By letting the invoice financier handle your credit control, collections, allocations and banking you are reducing your overhead by reducing man hours (either yours or your employees).  You also have this service without the interruptions of holidays or sick days.  Let’s face it employing people can be a pain, so outsourcing this vital function ensures a consistent and professional approach.
 
Supplier Discounts

With the extra cash available in your business you can pay suppliers faster and obtain discounts for doing so.  With cash so vital at the moment early payment discounts can vary from 1% to 5%!  At the higher end, this more than pays for the service charges from the invoice finance company.

Reduce Bad Debt

The Invoice Finance Company will undertake credit checks on your behalf and monitor collections.  Clearly whilst it is not feasible to eliminate bad debt completely you can certainly reduce the number of unpaid invoices by working within approved credit limits.  The Invoice Financier can also add on a debtor protection facility which, if manged correctly, will cover virtually all losses through bad debts.

Take advantage of discounted bulk stock sales

Having buying power is very freedom-giving.  It means that you can approach suppliers to negotiate bulk stock discounts.  You can also look at auction sales or fires sales as you will have ready cash to take advantage of ‘surprise’ offers.

So the £13,000 of costs can come back in a number of ways, cost savings, supplier discounts, and bad debt reduction.

But what’s it’s really about is more sales…and more profits

However the main reason clients use our services is the opportunity cost.  Factoring is an enabling facility for owner-managed businesses, it frees up time by outsourcing vital functions and it provides working capital for business growth.  If the £13,000 allows the business to grow sales and really grow profits then it becomes an almost insignificant amount.   Factoring thereby provides the springboard for business success.

The author of this article is Mark Byrne, Managing Director of Calverton Factors who provide factoring, invoice discounting and back office facilities for owner-managed businesses in the UK.  For more information visit www.calvertonfactors.co.uk.