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Invoice Discounting and Finance Options

18 February 2020

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Invoice Discounting and Finance Options

The two invoice finance options discussed here, namely invoice factoring and discounting aim to benefit business owners by providing fast finance solutions and helping them meet occasional needs for cashflow. To add, there is no need for the company to chase payments itself.

Invoice factoring

This involves selling outstanding debts to a factoring company who collect payments from your customers. You hand over control of your sales record to the lender.

Invoice discounting

This is a shorter-term invoice finance tool which allows business owners to remain in control of their sales book.

When an invoice is sent to your customer, as it normally would be when work is completed or orders have been fulfilled, an agreed portion of part of the total amount of the invoice (typically the advance is of 80-90 per cent of the original value) is deposited into your bank account from the lender, once the lender receives a copy of the invoice.

After this, payment can be collected from the customer as normal. The fees and charges are taken from the remaining balance and claimed by the lender. Charges should aim to be transparent and clear.

The difference between the two?

Both options are low risk and allow businesses to gain regular amounts of working capital. So, both are very similar other than the fact that for invoice discounting your customer may not be aware that the finance facility has been taken on. However, you can disclose the process if you wish, by placing a statement on each invoice to advise customers that it has been allocated to a third party but that your company will continue to collect payment.

When should invoice financing be used?

  • When your customers usually pay on time, with a minimum of 30 days to pay
  • You have minimal bad debts
  • You meet the minimum level of turnover required by the lender
  • Your credit control procedures are robust and effective. Credit management processes should be done in-house.
  • Your company has a reliable turnover

In essence, the buyers are interested in the credit risk of the debtor and not the seller so much so it can be beneficial to those with new businesses or poor credit ratings.

Finding the best invoice discount terms with lenders?

Many companies offer flexible invoice discounting, making it hard to choose the right lender. Some lenders limit the amount of cash they are prepared to advance or charge higher fees, especially if they see the industry by which you operate in as risky. You must negotiate and talk to the lenders to find the best deals and to acquire the best terms. Quotes are often made dependent on the industry you are in, the level of risk, the fixed rates of the lender themselves and the terms and conditions related (i.e. with or without recourse, confidential or disclosed, security involved?) – not forgetting of course the charge of VAT. Be aware that some lenders reduce their fees after a certain number of invoices have been sold or may offer credit insurance to reduce the risk of non-payment by your customers.

Invoice financing with/out recourse

With recourse means the lender has the rights to claim back the money which your customer fails to pay. You remain liable if the debt is not paid thus this option usually depends on the past payment history of your customer base and how confident you are in them paying back. This option is cheaper but riskier since you take all of it upon yourself. With recourse you also tend to find higher percentages of each invoice made as the lender is aware, they can legally reclaim the money if necessary.

If there is no recourse involved then you give additional risk to the lender hence higher fees and a lower cash amount involved. The lender accepts full liability for non-payment of your customer’s debts. If there are disputes or queries with any invoices this agreement would not cover it. Such an arrangement is suitable if there is slight doubt over the ability of your customer to pay now or in the future.

Single invoice factoring

Whereas other invoice finance facilities provide funding against the whole sales book, single invoice finance is the same in how it works but it provides a large cash injection from just one individual project/invoice. Hence it is quite useful for the construction industry.

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