“Paying on the nail!” No business likes to do this if it can possibly be avoided and deliberate late payment is spreading plague-like throughout large sections of industry in the UK. If companies continue to survive they are left with greatly diminished liquidity, but Richard Pepler, Chief Executive of Optimum SME Finance Limited, suggests some solutions to cash flow difficulties.
Faced with the problem of late invoice payment, it is surprising that still so little attention has been drawn to a course of aid which exists to fill a gap which has arisen in our more traditional commercial and banking systems. The service to satisfy the need and fill the gap is invoice finance (“IF”). It must be pointed out immediately that the factoring and invoice discounting industry is not a lifeboat, but is does provide the ability to unlock working capital at present tied up in book debts. Unfortunately, in the early days, IF was both misused and abused, but there is no doubt it is a very valuable tool for well-managed, expansion minded and profitable companies offering good products or services.
IF can have a relatively painless, but dramatic effect on the right sort of business. One of the novelties of IF is that it is one of the few types of funding which does not require a representative from the bank to assess a firms’ assets in great detail, right down to the Chairman’s house and his wife’s jewellery.
Instead, the company sends its invoices to the factor and immediately receives up to 90% of their value, the balance being paid when the factor has collected the debt from the customer.
Although borrowing from the bank is the obvious way of tiding over periods of high cash needs, IF can score above overdrafts by not being as limited in its scope. This means that small and medium sized businesses, which are often short on asset backing but long on sales orders, could find IF a more attractive source of working capital.
IF, however, is more than just the provision of funds. A factor takes on the responsibility of running and maintaining the sales ledger and thereby becomes an extension of the seller’s accounts department. The effect is to have access to the professionalism of very experienced accounts staff, credit controllers and a very powerful IT system. Just imagine an accounts department full staffed by experienced personnel, which never takes a holiday, never has sick leave, takes up no costly space and which is only paid while working for you! Such effectiveness can improve a seller’s cash flow and frees management from the headaches of administration, allowing valuable time to be devoted to what it knows best. In addition, a seller can acquire 90% protection against bad debts and there are many sad companies today who wished they had such cover.
What is the cost of such a service? This can vary between 0.20% – 1.50% of invoice value, depending on the workload and average invoice value.
If a seller costs his present sales ledger and credit control departments, space occupied, postage and telephone charges, plus management time – and is honest enough not to overlook the cost of possible ineffectiveness of his present organisation – the factor’s charge can often produce tangible savings with improved performance as a bonus.
Since all invoice financiers use sophisticated hardware and software systems, valuable additional services such as VAT and sales analyses can also be provided along with the normal sales ledger reports.
The professionalism of service provided by the invoice financier should, in itself, speed up client’s cash flow, but should you wish to take advantage of the cash facility also, the factor is able to make available funds of up to 85% of the outstanding approved invoices.
Let is take an example where a company has approved invoices of £100,000 outstanding. Several of its debtors are large industrial companies, which sub-contract to many small firms, and it is a well-known fact that such debtors take anything up to six-months credit, certainly a lot longer than the actual credit terms of the seller. A small company is forced to accept such a situation for fear of losing the contract. It is unable to progress any further since it has no free working capital left to expand and/or acquire a better spread of customers – which is not the reason for being in business! If further outside capital is introduced, control could be lost.
In the case of our example, approved invoices amount to £100,000, in which case, up to, say, 85% (£85,000) could be released immediately, if required to the seller, the 15% balance when the customer pays.
Any manufacturer or supplier would know what to do with £85,000 if the opportunity arose. A good credit rating can be maintained with suppliers, and discounts on purchases can be obtained. Supplies can be purchased in more economic quantities and seasonal peaks in cash flow requirements can be met. Production can be increased with the sure knowledge that as turnover grows, the cash facility grows with it – unlike the bank overdraft which, as we know from experience, can be pegged, reduced or withdrawn at most inconvenient times. The cost of such cash advance is in the order of 2.50% over base rate, often less than normal bank overdraft rates. Interest is charged only on the amount of advance outstanding on a day-to-day basis in arrears, just as in an ordinary bank account.
Having outlined the operation and benefits of IF, take a look below at the situation a Bristol based company was facing when it approached us recently requesting IF.
Established 3 years, trading profitably
Freehold property – NIL
Paid up capital £15,000
Bank overdraft £90,000 secured by a debenture
The company is enjoying vigorous growth.
Problem: Cash flow forecasts by the auditors for 2017 showed a need for increased working capital. An approach to the bank had resulted in an offer of increased facilities if the directors injected more capital into the company. This they were not able to do.
Following a visit to PTP Limited the following agreement was proposed:
Funding – (prepayment) 75% on invoice values including VAT
Interest Cost – (discount rate) bank base rate + 2.5% calculated on a day-to-day basis.
Service Charge: 0.8% on discounted turnover.
We arranged immediate funding of £206,000 against the ledger which left the bank account £116,000 in credit, with a further availability of £60,000 which could be drawn against as and when required.
This facility was provided quickly and with the minimum inconvenience.
The above example is typical of many IF circumstances, and highlights that IF is a “success related facility” as opposed to the old-fashioned security related facilities under which companies could borrow money only if they had a lot of it already.
Most traditional forms of finance are inflexible. Overdrafts, for instance, take time to arrange, they are restrictive and need to be renegotiated each time an increase is required, even if only temporarily. Companies which first look at IF are often startled with the amounts that can be realised. They come to see it as far more convenient and cost effective way of raising finance than those available from clearing banks.
It is essential that funds from IF are used to promote continued profitable expansion. IF is not a panacea of ailing, badly managed companies which will meet their fate regardless. However, it is an extremely valuable service if used correctly and can assist businesses in good and less good times, to sustain controlled profitable growth without cash flow problems.