Invoice discounting: the basics

Invoice discounting is an alternative way of drawing money against your invoices that allows you to retain control over your sales ledger. It can provide a cost-effective way to improve your cash flow. Invoice discounting is only available to businesses that sell products or services on credit to other businesses and isn’t normally available to retailers or cash traders. It is normally only available to businesses with a proven track record and an annual turnover of at least £50,000.

However, it may not necessarily be the cheapest form of finance available and can tie you into a long contract.

How it works

Invoice discounting provides a fast prepayment against your sales ledger. It allows you, at a cost, to flexibly increase your working capital and improve cash flow. The invoice discounter will want to visit your business, review your finances and study your business plan to evaluate your suitability for invoice discounting. They will also regularly check that your business procedures are effective.

You will pay a fee to the invoice discounter, usually a percentage of the value of the invoices or an agreed fixed fee and discount (interest) on the net amount advanced. They will be notified of the invoice details electronically – through downloads of sales day books or invoice listings. Once they receive notification, the invoice discounter will make funds available at the agreed percentage rate, which you can then use as required. As cash is received from debtors, it is paid to the invoice discounter, reducing the outstanding balance and making the remaining amount available.

Further invoice notifications will generate further availability – so your account balance will fluctuate as invoices are assigned, funds are drawn and cash is received. The invoice discounter will recalculate the amount available to you after every transaction.

You are not required to inform your customers you are using invoice discounting, as you still collect the debts and do the credit control. You can choose between recourse and non-recourse facilities, determining who is responsible for recouping unpaid invoices.

Selective Invoice Discounting

Selective Invoice Discounting is only offered by a few financial providers, and allows you to choose individual invoices or customers/debtors for discounting and so receive funding on an invoice-by-invoice basis. This flexibility is ideal for smaller businesses – especially if you deal with large single orders, single customers or have seasonal trading patterns.

Fees for Selective Invoice Discounting are higher, but it can be more cost-effective as you won’t need to process all invoices through the facility. You may have to pay an account set-up fee and there is often a minimum invoice value.

 There are a number of benefits of using Selective Invoice Discounting, including:

·      greater flexibility – you don’t have to notify the invoice discounter of all sales invoices and you only pay fees for invoices you use

·      quick funding - the simple process often allows providers to complete within days

·      open contracts without long term ties

·      no leaving fees for ending an agreement

·      as with invoice discounting, you still manage debtors’ accounts and can maintain business relationships - but you can ask a provider to help with credit management

 You should not enter into any Selective Invoice Discounting agreement if you are in dispute or facing queries from a customer or debtor. You should be aware of the costs associated with any agreement as these can be expensive and could affect your profit margin.

The cost of factoring and invoice discounting

The costs of factoring and invoice discounting can change depending on the company offering the service, and are often negotiable. It is a good idea to consider several suppliers, and compare the:

·      discount charges (interest) offered

·      service or management fees

·      any additional costs - eg for additional services such as credit protection

·      notice period for ending the service - most providers require three months’ notice, but some have notice periods of up to a year which could be expensive for your business

Discount charges

Discount charges work in exactly the same way as bank interest. Typical charges range from 1.5% over base rate to 3% over base rate. The discount charge is calculated on a daily basis and usually applied monthly.

Credit management fees

There will be a fee for credit management and administration. The amount will depend on your turnover, the volume of your invoices and the number of customers you have. Typical fees range from 0.75% of turnover to 2.5% of turnover. For invoice discounting, fees are typically lower than for factoring because you will still collect and manage debts yourself. They generally range from 0.2% to 0.5% of turnover. These fees are less because the level of service provided is significantly lower than with factoring.

Credit protection charges

These will be levied in non-recourse factoring arrangements, where the factor is liable for any bad debts. The amount will largely depend on the factor’s assessment of the level of risk.

Typical charges range from 0.5% of turnover to 2% of turnover.

Export factoring

Some factoring companies offer a facility for the financing of international sales. They will typically work with a partner abroad who will be responsible for the collection of payment in the country to which you export. The services of a local agent will prevent any problems that could arise because of differences in laws, customs, language and time differences. In terms of credit limits and process, there is no material difference between local and international factoring.

Some factors will offer you the choice of being paid in sterling or in another currency. You should carefully evaluate which is to your advantage. If your customer insists on being invoiced in their country’s currency, consider investing in protection against currency fluctuations. Factors may approve a lower level of prepayment for export invoices than for local sales.

Requirements for export factoring

You normally only need to have an annual turnover of at least £100,000. This can include domestic sales. Companies based in the European Union (EU) can still factor debts owed from other EU countries if sales within that country are relatively small.

Outside the EU higher sales to a single country will be required. For the USA annual sales of £500,000 will typically be necessary. Export factors will usually charge more if the volume of sales is low.

Features of export factoring

You can choose to invoice in one currency and be paid in another. Many customers prefer to be invoiced in their own currency. You can be protected against currency fluctuations. The cost of export factoring is usually slightly higher than the cost of domestic factoring, but less than the cost of export finance.

 You can minimise the bad debt risk by purchasing credit protection. Most factors insist on this.

How to choose a factor or invoice discounter

There are a variety of providers to choose from when considering factoring or invoice discounting, including subsidiaries of major banks and financial institutions, or independent providers.

Smart Business Finance; the people to speak to if you want to find out more…

Questions to ask

What is the funding provider’s record in collecting debts quickly and efficiently?

How exactly does the provider operate?

What are the procedures in detail and do they suit you?

How does the provider handle disputes and queries?

As the factor will become an ‘insider’ and be in frequent contact with you and your staff, do you see eye to eye on issues that are key to your business?

Do you have a good initial rapport?

Does the provider have experience of your industry?

How is the provider likely to communicate with your customers (if it is a disclosed arrangement)?

 You should agree a general customer service policy with them to ensure they will not alienate your customers.

What will happen if a customer goes over the credit limit?

What happens if you want to end the agreement?

What period of notice must you give?

Most providers require three months’ notice, but some have notice periods of up to a year which could be expensive for your business.