Factoring and other forms of invoice financing are ideal for companies wanting access to funding, from startups to large corporates. But it is a complicated market; there are many types of invoice financing and dozens of providers with different terms and products. So here are five key questions to ask before signing up.
Is invoice finance right for my business?
Under invoice financing, a company gets paid by a finance firm when an invoice is issued instead of waiting for a customer to pay up, meaning cash is no longer tied up in accounts payable.
Adam Stevens, credit insurance consultant at Allianz Trade UK & Ireland, notes: “Invoice finance means companies can generate the cash to deploy where they most need it.”
But invoice finance, as its name suggests, only works for companies that issue invoices to other firms. So if your firm does cash business with the public, it is not available.
Also, invoice finance doesn’t solve underlying business issues. If your real problem is falling revenues or slim margins, these need fixing before invoice financing will be available at a reasonable cost.
How much will invoice finance cost?
A key figure to check is the discount margin, which is equivalent to the interest rate on the advanced funds, which can range typically from 0.5% to 4%. Usually, a service fee is also levied as a percentage of business turnover. Plus, there are setup and legal fees.
There are many providers, and inevitably this means some players do not have full transparency on fees. Scrutiny is essential.
Also, ask about termination fees. Invoice financing can be a long-term way of helping cash flow, but if it doesn’t work out for some reason, you need to be able to escape without painful penalties.
Factoring? Or Invoice discounting?
There are two types of invoice financing:
Factoring where the invoice financing firm advances cash against invoices then does all the work chasing for payments; and
Invoice discounting where the invoice financier advances cash against invoices but you retain your accounts payable department and chase for payment as usual.
If your turnover is less than £100,000 (about €120,000) you will likely have to use factoring. Above that, you likely have a choice.
And it’s a critical distinction. Some firms want to control their whole customer relationship, so they choose invoice discounting (which also has lower fees). Others like the idea of, in effect, outsourcing the collection process. Adam Stevens commented: “If you’re an infant company, maybe you don’t want to pay someone to do collections.”
All your invoices? Or just some?
As the market has matured, new products have become available. One important new option for larger firms is to use an online platform to send only some of their invoices to the finance company for immediate payment while processing and collecting the rest internally.
This flexibility can help reduce costs. For instance, a logistics firm may have a cash crunch in the run-up to Christmas, so it will send more and bigger invoices to its invoice financing firm. Then, for the rest of the year, they will send fewer invoices to keep down costs.
Do I need bad debt protection?
Most invoice finance is “recourse financing”. In other words, if the customer fails to pay after a set period, then the finance company will reverse the cash advance and send the invoice back to you. This unpaid invoice is now your problem.
Many providers will, for a fee, bundle “bad debt protection” but this may be inflexible. So it’s important to know that trade credit insurance can be bought separately, with providers such as Allianz Trade UK & Ireland very experienced working with firms using invoice discounting.
Why buy separate protection?
- Separate trade credit insurance can be more flexible and tailored to your firm;
- It can cover all a company’s invoices even if some are not discounted, giving more effective control of risk; and
- Costs will typically be lower for a given level of cover.
Adam Stevens of Allianz Trade comments: “We’ve saved businesses a lot of money by working directly with us.” He also notes Allianz Trade can provide companies with superior credit limits and cover them for all their risk, not just the invoices that are discounted.
In addition, there are very substantial benefits to working directly with a trade credit insurer, including information exchange on creditworthiness issues—vital when making decisions about export markets.
There is a lot of innovation in the invoice finance market. Choosing the right provider can be a challenge. Our up-to-date article Invoice finance: a buyer’s guide (2022 edition) has much more information to help you make the right choice.