The term invoice or receivables finance seems to instantly invoke thoughts of factoring in the minds of many business owners and finance directors.
Factoring is one of the oldest forms of commercial finance that probably explains this thinking though in more recent times, new technology based lenders are offering very competitive invoice backed business loan alternatives. These loans differ in many ways from the traditional factoring arrangement and importantly for businesses, can result in some significant cost savings though have other differing factors to be considered before deciding what works best for your business.
Factoring involves a business selling their outstanding invoices or receivables to a specialised finance company (the “factor”). The business sells the invoice at a discount to provide liquidity and the factor then (at least in most instances) assumes the risk on the receivables being collected. The factor typically charges between 1.5% to 4% of the invoice value and may also impose additional transaction or facility costs. Payment of the invoice is to the factor (meaning that the debtor is aware that the invoice has been assigned to a third party) that is then applied to the initial factored amount plus fees and charges and any surplus paid through to the business.
Factoring can be a good solution for various businesses, particularly those that don’t have the resources for the management and collection of invoices, though there are two key issues to consider:
- Cost – factoring can be costly. Take an example where a business is constantly funding an average of $100k of receivables on 45 day terms. At the low end (1.5% per invoice) the effective rate on this funding would be around 12% pa and at the high end (4% per invoice) in excess of 30% pa. There may also be a number of other associated management fees to be considered and incorporated in the overall cost.
- Disclosure – depending on what sector you operate in, factoring may create a perception with your clients that your financial stability is weaker than your competitors. This may result in your clients favouring your competitors for future work or trying to negotiate harder with your business before awarding future work.
Invoice Finance differs from factoring in that it is effectively a line of credit for your business that is secured by your portfolio of invoices. The business retains ownership of the invoices and as such, the funding arrangement is typically not disclosed to your clients. The cost structure of these facilities varies between lenders though are typically more akin to a normal business loan with an interest rate applied to the size of the loan. The facility size is generally based on a level equal to 80% of your total invoices (that are less than 90 days).
There are various benefits of an invoice finance facility over a factoring arrangement including:
- Lower Cost – Invoice Finance will typically be significantly more cost effective than a factoring arrangement (especially if your business is factoring invoices at or above 2% per invoice)
- Confidentiality – Typically non-disclosed to your clients
- Flexibility – Access funding when required based on your level of invoices (rather than being obligated to factor out each invoice that also goes back to cost)