As Vince Cable has recently pointed out, banks are still reluctant to lend to small and medium sized businesses.
This lending is essential to give SMEs the working capital needed and get the UK economy back on track. Instead of traditional overdrafts and loans one other way of getting the funding your business needs is through invoice finance. As well as the banks, there are a number of independent invoice finance companies that are able to provide this funding.
How can invoice finance help my business?
Invoice finance is a broad term to cover both factoring and invoice discounting. Both will lend you money against your outstanding sales ledger.
With factoring the lender will also chase and receive payment. With invoice discounting you run your own credit control and then repay the lender once collected.
Releasing cash tied up in your sales ledger provides essential cash flow for your business. As soon as the invoice is raised you are advanced funds against it, up to 95% of the invoice value.
If most of your business is B2B, you give credit terms and you only invoice for completed (not ongoing work) then invoice finance should be an option, so you need to look at the cos
Orders can be expensive to fulfil and no one wants to be turning away business because they’re still waiting payment from previous orders.
Costs of invoice finance
There are two main charges for this service. The service fee, which is a percentage of company turnover. The second charge is the interest of the money actually loaned.
The service fee is to cover the cost of running the facility and the provider’s profit. The larger the turnover the lower the percentage but the greater the overall cost.
The interest is usually set as a percentage over base rate, but with interest rates currently so low they will set own minimum base rate or use LIBOR, the rate at which banks lend between themselves.
A minimum monthly fee will also be applied to make sure the provider at least covers its costs should the value of the outstanding sales ledger not be as high as expected. Some providers will rely on this figure, so when considering quotes it is important to compare this cost against what you would expect to pay via the service fee and interest.
How do I decide if invoice finance is right for my business?
Not all businesses are suitable for invoice finance, for example lenders will only finance invoices to business customers, they will not lend against domestic customers. If a significant percentage of your outstanding sales ledger is for domestic customers then invoice finance may not be right for you.
Whilst start-up businesses can use invoice finance, you can only borrow against existing invoices. It cannot be used as a cash injection to get your business off the ground unless you are already trading and giving credit terms to customers.
If most of your business is B2B, you give credit terms and you only invoice for completed (not ongoing work) then invoice finance should be an option, so you need to look at the cost.
A business with a turnover of over £1m is likely to have a service fee below 1% of turnover, however a business with a turnover of £100k is likely to have a service fee of between 2.75% and 3%. We can look at how the cost of borrowing using invoice finance compares with a loan or a bank overdraft using a few simple sums:
The small business
If we user a smaller firm as an example e.g. one with a turnover of around £100k with 90% advance and with clients paying on average after 60 days then overall cost on monies loaned could be quite high:
Turnover: £100,000
Sales Ledger: £16,000
Money loaned (90% advance on £16,000):£15,000
Service fee (3% of turnover): £3,000
Interest (5.5% of 15,000): £750
Total Cost: £3,750
As you can see in the above example 3% of turnover equates to £3000 per annum, the interest on the monies outstanding is £750 per annum. If you look at the amount of money the company is looking to borrow at anyone time £15,000 (90% of the outstanding sales ledger), then £3,750 per annum is quite a large sum of money to pay to borrow £15,000. If it was a straight forward loan it would equate to 24% interest.
A couple of invoice finance firms appreciate this is not cost-effective for most businesses of this size and will offer special rates for small businesses.
The medium-sized business
A medium sized business with a turnover of £1m would expect to pay a service fee of about 0.7%:
Turnover: £1m
Sales ledger: £110,000
Money loaned (90% advance on £16k):£99k
Service fee (0.7% of turnover): £7k
Interest (5.5% of 99,000): £5,445
Total cost: £9,195
In the example above the 0.7% of the turnover equates to £7,000. The money advanced is significantly greater so the total interest payable more.
The overall cost for such a company would be £9195, as a percentage this works out as 9.29%. This is a quite a reasonable rate and especially so given it covers the cost of running a professional credit control function. Invoice finance is also flexible growing with your business.
Is it cost-effective?
One simple equation to do when trying to decide if invoice finance is cost-effective is to ensure your gross profit is greater than the cost of the capital. In simple terms if it costs you £100 to make a widget and you sell the widget at £125 you need to make sure the overall cost of the invoice finance is less that 25% otherwise it is costing you more to borrow the money that you will make from investing the money.
Of course cost whilst one of the main factors in choosing an invoice finance facility it is not the only one. A decent invoice finance broker, independent financial advisor or accountant should be able to assist you with a break down of costs and have the industry knowledge to find a flexible facility that most closely matches your businesses’ needs.
