Invoice Finance – factoring or discounting?
Like many industries, the invoice finance industry is full of jargon which can make it difficult to understand if it’s not something you are used to.
This has a dual effect; firstly, it means the customer often doesn’t have sufficient knowledge to choose the right product or negotiate the right price, and secondly, the providers of these products are – in some cases – able to sell in more costly services than are needed.
Essentially, this is all about knowledge-sharing or knowing what you are talking about and, of course, isn’t peculiar to the invoice finance industry – it’s the same in every industry I have ever known.
To help you negotiate your way through the language of invoice finance then, we offer below the following key information on each of the main invoice finance products out there. And, in addition, provide you with explanations on much of the jargon used in the industry to assist you in both your choice of service and also, any subsequent negotiations with potential providers.
Back to basics
The two principal products we will discuss here are Invoice Factoring and Invoice Discounting.
Let’s start with the basic difference:
- Factoring facilities are a complete outsourcing of the sales ledger, with invoices being collected by the factoring company in their name. The factor will buy the invoice from you and this will be disclosed to your customer by a notice on the invoice.
- Invoice Discounting facilities are in most cases confidential, in that your customer is not aware that you are receiving a funding line secured against your invoice to them. You retain control of the credit control function.
Both products will provide an advance against your invoice value at an agreed percentage rate (typically 75 to 85%) at the time you pass the invoice to the invoice finance provider. The balance will be paid at the time of payment by your customer. The providers will charge two basic fees, a service charge for providing the service, and a Discount fee, which is the interest on the money you are borrowing. The discount fee can be over Bank rate or LIBOR. These fees are taken on an on-going basis from your account.
The Jargon
Let’s move on now to a more detailed explanation of the products, and the jargon, and explore which could be right for your business.
Factoring – This type of product is predominantly used by the smaller businesses, that don’t necessarily have a long trading history or sturdy balance sheet, and possibly don’t have their own credit control function.
Invoice Discounting – This product is often referred to by the acronyms ID or CID, or often just as Discounting. Because of the confidentiality, and the fact that the credit control remains with you, this product is the preserve of the larger (£500k plus) business, although there are always exceptions. Payments by your customers are made into a Trust account that is in your name but under the control of the provider
Minimum fee – the monthly fee you will be charged however much invoicing is raised. This should normally be at a level lower than your forecast turnover
Retrospective fee, also known as the Retro fee – is the fee charged for taking on your existing ledger and is normally the same as the Service charge percentage.
Arrangement fee – the cost of setting up the facility.
Initial payment or prepayment percentage, often referred to by the acronym IP – is the percentage advance you receive at the time of raising the invoice.
Funding limit – the total funding line you can receive however high your turnover goes.
Approval period – the number of days that the provider will fund your invoices for. After this period, say 90 days, invoices still outstanding will become un-approved, and the amount will be deducted from your overall availability.
Recourse – the term used to confirm that in the event of non payment of an invoice the liability remains with you at all times.
Non-recourse – where credit insurance has been secured and your risk is reduced.
Refactoring fees – these are applied where an invoice has been outstanding for longer than the approval period
High involvement – a term used for individual customers who account for a large percentage of your sales ledger. The provider of the facility may restrict the percentage of any one customer to a specified amount. If you have a large customer the provider will often make an exception and increase the percentage for this specific account.
Dilution – the level of credit notes that you would raise in a period. If this is too high it will concern the provider as it could potentially have an adverse effect on their security.
Disbursements – the term used to cover all other additional charges such as faster payments or temporary increases in the facility amount.
INSIDER TIPS
1. Minimum monthly fee. Try to negotiate this as low as possible as it can be a cost you could do without if your business drops. Don’t over estimate your turnover as this is what it will be based on.
2. Disbursements. Make sure you have a full understanging of any additional charges over and above those that are included in your agreement.
3. Minimum base rate. There may be a minimum base rate or LIBOR rate that applies to your proposed agreement. Try to avoid this.
If you have any comments on this article or would like to discuss invoice finance generally and whether it is right for you please contact me at john.thompson@transcapital.co.uk or on 0845 689 8750.
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