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Banks, Lenders & Investors Cash Flow & Forecasting Factoring, Invoice Discounting & Asset Finance Finance Insolvency

Can SMEs afford to use invoice discounting and factoring?

invoices in filing cabinetBoth invoice discounting and factoring are a means by which a business can borrow against the value of its invoices before they have been paid.
They can be a useful way of funding working capital and managing cash flow, especially for a rapidly growing business, but they also come at a cost.
Not surprisingly the finance comes at a cost which will depend on the services being provided, interest charged and risk of loss to the lender, some being less scrupulous than others.
The amount charged will cover interest on funds drawn and a service related fees. The service fees will change depending on the volume of invoices, value of invoices, concentration of invoices, percentage drawn down, maximum amount borrowed, the level of monitoring necessary and any credit insurance. They can also include set up, audit and introduction fees.
The funding agreement, often hidden in the small print, will include event fees such as termination fees, default fees, collection fees, notice penalties. Many also require the support of personal guarantees. On the face of it they can’t lose money, but you would be surprised at how many do.

What is the difference between invoice discounting and factoring?

With factoring, the service provider takes on managing the sales, ledger, credit control and chasing of invoice payments. With Invoice discounting the business remains responsible for its sales ledger and invoice chasing.
When considering whether to use either service businesses should weigh up the costs against the benefits of freeing time to manage the business (particularly in the case of factoring) and the enhanced control over cash flow, especially if it is intending to grow.
However, again, particularly with factoring, other borrowing avenues will be restricted because book debts will not be available as security.  While this choice provides some protection against bad debts, factors will also restrict your borrowing against poor quality debtors by either disallowing them for borrowing purposes or recording them if they aren’t paid within terms.
In terms of customer service, a business will need to consider the effect on its customer relations of having no direct contact with the business, and especially, how the factoring service treats its customers.
With invoice discounting a significant consideration is how robust the business’ in-house credit and invoice processes are and how the service compares with the rates that may be charged on an overdraft or bank loan. It should be pointed out that banks no longer want to provide overdrafts as a way of funding book debts.
In both cases, the event fees can be sufficiently large to justify some lenders looking for reasons to trigger them. Even with scrupulous lenders, regular defaults become a problem for both parties.
While both services may be an option to consider for a healthy business, it is questionable whether they are helpful to a business that is already in financial difficulty. Turnaround advisers often find themselves having to negotiate on behalf of companies with factors and invoice discounters to persuade them not to pull the plug when, although the money loaned is covered the lender wants to end the relationship and recover their money.

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Cash Flow & Forecasting Factoring, Invoice Discounting & Asset Finance Finance General Insolvency Rescue, Restructuring & Recovery Turnaround

Is there a solution for SMEs struggling with lengthy payment terms?

Large companies that impose lengthy periods of ‘end of month plus 90 days’ for invoice payment present a dilemma for small businesses.
On the one hand it may bring in large orders and be good for their reputation as a supplier to a well-known large brand. On the other hand, however, the lengthy wait for payment can cause serious cash flow difficulties.
Large companies are getting away with imposing such terms despite being named and shamed, the latest being beer company AB InBev (payment in 120 days) and Heinz (payment extended to 97 days).
In an attempt to hold companies to account, the Federation of Small Business (FSB) has called for a compulsory code committing large companies to displaying their maximum and average payment terms.
While we can certainly sympathise with the outrage over this behaviour and agree with FSB’s request that firms disclose their longest and average payment terms, there are ways that SMEs can fund themselves while they wait for payment.
Apart from an overdraft or loan secured against assets such as the sales ledger the obvious solutions are factoring invoices (selling debt) or invoice discounting (borrow against invoices). There are other sources that can help fund working capital such as credit to customers. These include the alternative and online funding markets that have a number of sales ledger and single debt offerings including the prospect of selling or borrowing against as single invoice. Another solution is trade finance, although quite specialist it is useful for funding large transactions and especially useful for SMEs when they get a large one-off order.
K2 publishes a Business Finance Guide covering a wide range of options for business finance, available free through the Knowledge Bank on our website

Categories
Banks, Lenders & Investors Business Development & Marketing Factoring, Invoice Discounting & Asset Finance General

Is the Economic Recovery Being Imperilled by Banks’ Continued Failure to Lend to SMEs?

Despite government rhetoric, evidence continues to pile up that the banks are still not lending to Small and Medium-sized Enterprises (SMEs).
We are hearing that when companies apply for any lending the banks are only considering loans or overdrafts secured on tangible assets, with most also demanding personal guarantees from the directors in addition.
Total net lending by the UK’s five main banks fell in 2011 and they missed their lending target to small firms, whose use of bank overdrafts and loans has also declined over the past two years.
The FSB reports that of 11,000 SMEs just one in 10 obtained a bank loan in 2011 and that 41% of applicants had been refused loans in the three months to February 2012. The FSB believes the UK banking system is not geared up to lower end loans of less than £25,000, because “there’s no money in it”.
Business Secretary Vince Cable has warned that recovery is being imperilled by the “yawning mismatch” between bank lending and SME demand for finance and at the end of April economists at Ernst and Young predicted that they expected lending to reduce further this year by 6.8 per cent, to £419 Billion.
Meanwhile invoice discounting and factoring have increased significantly, though banks are seemingly no longer offering these facilities, leaving the door open for independent companies such as Bibby, Close, Centric, SME, Ulitmate and the new British bank, Aldermore.
Are the banks struggling or are they simply withdrawing from the SME market?
We think the banks are being deceitful. Whatever the rhetoric, they are using PR tactics to report new loans, which are in fact not really new lending but the refinancing of existing facilities such as turning an overdraft into a term loan or a factoring facility.
This is piling even more pressure onto small businesses because there is a net decline in the flow of money into SMEs, and furthermore any new money is being provided at a very great cost in terms of fees and interest. While high rates of lending may be justified by the risk when it is unsecured, it is not justified when the loan is secured.
K2 would be very interested to hear from SMEs that have managed to secure a bank loan.

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Debt Collection & Credit Management Factoring, Invoice Discounting & Asset Finance General Rescue, Restructuring & Recovery

Factoring and Invoice Discounting: Be Wary of Hidden Fees

Factoring and invoice discounting (borrowing money against invoices) can be a helpful tool for funding the working capital of a business.
While it used to be regarded as a means of borrowing by businesses in financial difficulties, it is now a common source of finance for managing cash flow and has the additional benefit of imposing discipline on the collection of outstanding sales invoices.
The service charge fee is pre-agreed with the finance provider and generally relates to the level of service provided. Fees for factoring are generally at a higher rate of between 0.8% and 3%, than for invoice discounting because the factoring service charge includes debt collection.
However, hidden in the small print are usually contingency fees that can be triggered by a default. These fees are sufficiently large to justify some lenders looking for reasons to trigger them.
There are many examples of companies in financial difficulties where the factor or invoice discount provider pull the plug on a facility and collects in the outstanding debts to recover funds loaned as well as their retaining the default and recovery fees.
Typical default fee are 10% of the ledger held plus recovery fees which are generally not specified. Such is the scope for earning fees that advisers to lenders might be persuaded to recommend the exercising of rights under a default knowing that they, as advisers, can be paid out of the recovery fee clause as well as repaying their lender client the loan and default fee.
Such self interested behaviour may swell the coffers of lenders but it doesn’t help preserve businesses or improve the reputation of the finance community.