How to Maximise Cash When Invoice Discounting or Factoring
A lot of our clients want to ensure that they can maximize the cash generated by an invoice discounting facility. As such they compare different offerings based on the headline rate of the prepayment. For example they assume that a facility with 90% prepayment will generate more than a facility with 85% prepayment. This may well be the case but it is important to understand that the prepayment is applied to what is termed ‘eligible debt’. The eligible debt can differ from lender to lender and various restrictions or limits can be imposed that can restrict the eligible debt.
Some lenders are actively targeted to achieve a certain rate of return on the funds they lend. This can be done by achieving certain fees or by charging reduced fees but restricting funding.
In order to maximize cash generation you really need to understand what constitutes eligible debt and what can restrictions can impact upon cash flow. Let’s take a look at a few factors that can impact:
The recourse period is the time frame after which the lender stops funding an invoice. Some lenders will offer a 60 day recourse period which means that any invoices over 60 days old will not be funded. In fact when the invoice hits 60 days it is ‘recoursed’ back to the client and funding is withdrawn from availability. If you are up against your limit this can actually put you in an overpaid position. In contrast some lenders offer a 120 recourse period and in some instances longer. In these times where payments take longer to receive it is imperative you understand the impact that a facilities recourse period can have on the funds generated and ultimately your cash flow.
The concentration limit is the amount of debt that a lender will allow with a single debtor. Many of the bank owned invoice discounting providers implement a 30% concentration limit. By way of an example let’s consider a new start temporary recruitment business that has landed it’s first contract supplying staff to a well known supermarket chain. Their headline prepayment is 80% and the concentration limit is 30%. At the end of month 1 they issue an invoice to the supermarket for £100,000 and notify this invoice to the bank owned invoice discounting company. They have to pay the staff so they are keen to access the 80% of the invoice they are expecting. However, the eligible debt is only £30,000 because of the concentration limit. As such 80% is applied to the eligible debt and only £24,000 is made available.
This scenario is very real and is one I have encountered several times. The result can be catastrophic for the client who may not be able to meet wage demands.
Overall Facility Limit
Many businesses who enter into factoring and invoice discounting facilities do so to finance rapid growth. When they enter into the facility they may only have a £500,000 ledger and as such a £500,000 facility may seem sufficient. However, 6 months later due to growth their ledger may be £1m. The £500,000 facility limit will prevent them from receiving any more than £500,000. This may prove restrictive for the business, it’s cash flow and it’s growth plans.
This is where forecasting is important but also the choice of lender is key. Some lenders are unable to lend above a certain amount so if you are tied into a contract with a lender who is unable to fund above £500,000 you would not be able to receive funding above that amount until your contract was complete and you could move lenders.
Many businesses in the UK will have an element of export sales. Many view this as a real opportunity to expand and grow into new markets. Lenders have different approaches to exports. Some are not happy to fund them at all so cash against export invoices are not an option while others may impose an export cap. A typical export cap from a well known lender is 20%. This means that they will only consider exports as eligible debt if they are less than 20% of the overall ledger.
As the client you need to understand what the export cap is and what the impact will be on the cash generated both now and in the future.
Importantly some lenders are happy to provide a 100% export cap meaning the whole ledger can be exports and it will not impact on the cash generated.
This is the most common restriction on funding that we see. Each individual debtor is assigned a limit. If the debtor has a £200,000 balance with your business but the limit is only £100,000 then funding will be restricted. In some instances this can be against blue chip debtors as your lender may feel that already have too much exposure to that particular company. As such you are being restricted because of the money they are lending other clients against that particular debtor.
How can Funding Solutions help you?
At Funding Solutions we take into consideration the structure of your business, your growth plans, the customers that you deal with and the structure of your debtor ledger. From there we can anticipate what restrictions certain lenders may impose. Our knowledge of the invoice finance market means that we can help you structure a facility that minimises costs and maximizes cash flow.