Using factoring and invoice discounting to smooth cashflow and fund investment

Until recently, asset-based lending was rarely used in the relatively glamourous world of corporate dealmaking other than to fund the turnaround of companies in serious financial distress. Back in 1995 fewer than 12,000 companies used an assetbased facility in the UK. According to the Asset Based Finance Association (ABFA), that figure now stands at more than 48,000.

Full-blown asset-based packages – lending against the stock, machinery, debtor book and all manner of other assets – are still used to fund management buyouts/buy-ins or provide working capital for companies that fall into the turnaround category. A growing number of entrepreneurs, though, are using two subsets of asset-based finance – factoring and confidential invoice discounting – not to effect a corporate rescue but simply to smooth their cashflow and provide working capital without having to put their houses on the line.

In both forms of invoice finance, the lender takes ownership of the invoiced debt. Under a factoring agreement, which costs more than invoice discounting, the factor takes over your sales ledger administration and credit control. As with invoice discounting, a percentage of the total debt (usually around 80 per cent) is forwarded by the factor within 24 hours of the invoice being raised, with the remainder (minus fees) being remitted upon settlement of the bill by your customer.

Invoices can usually be insured – if they are not, and your customer defaults, you will have to repay the lender any sum they have forwarded to you secured against that debt.

Invoice discounting operates a little more like an overdraft. You retain responsibility for your sales ledger and credit control, but a facility (say up to £1 million) is agreed with the bank against which you can draw a percentage (again, typically up to 80 per cent, though this will vary depending on the strength of your covenant) of each invoice at the time it is raised. Only business-to-business invoices can be discounted or factored.

Costs vary according to your size, credit rating and a number of other considerations, explains Kate Sharp, chief executive of ABFA.

Charges are split into cost of money, known as a “discount charge” (effectively interest), and a service fee.

The former, she says, is broadly comparable with, and can be cheaper than, borrowing money from a bank – and will depend on how you are rated as a risk. The latter is usually, but not always, based on your turnover, and usually charged as a monthly fixed fee – and again takes into account things like your risk rating and level of service required.

A full factoring service, she continues, will charge between 1.5 and three per cent of turnover, dependent partly on workload – you will pay more if you have thousands of small invoices to process than if you just deal with a few high-value clients.

Charges on confidential invoice discounting, meanwhile, range from a few basis points for large, secure companies to up to two per cent of turnover for smaller, riskier businesses.

Ultimate Finance is an AIM-listed, Manchester-based factoring and invoice discounting business founded in 2002 by Brian Sumner, who has now clocked up 40 years in the industry. He says factoring has suffered a bad rap over the years, but that this has partly been the fault of the big banks: “They sell it cheaply but then don’t look after the debtor book properly or insure the clients.”

Sumner set up one of the UK’s first invoice discounting (as opposed to factoring) businesses for US Bank Boston Financial – an operation acquired by Lloyds TSB in 1987. He says, “Confidential invoice discounting is suitable to a much more varied group of businesses because they like handing the debt collection themselves.”

With both forms of invoice finance, though, he warns against sales practices reminiscent of those used by banks to lure consumers in with incredible headline rates on savings accounts that mysteriously evaporate after six months.

“An invoice discounter will typically lend between 70 and 90 per cent of the value of the debtor book,” he explains. “One lender might offer to advance you 90 per cent of your order book when another has only offered 80 per cent – but as soon as it has you as a client it will look to scale this back, which is a bit sharp.”

Nonetheless, a number of companies in the region have used invoice finance at various stages of their growth with great success – indeed, it has formed the core of a number of business models.

When advertising salesmen Gary Wilkes and Andy Coffey launched Seniorcom, a publisher of free magazines targeted at the over-50s, in February of this year, they knew cashflow was going to be an issue and set about doing some research on the internet. This led the Boltonbased business to Skipton Business Finance (a subsidiary of Skipton Building Society).

Wilkes explains that the business decided to take a full factoring service from Skipton because “we were looking for a very quick turnaround” and that it made sense from a cost point of view.

“We looked at the costs of employing a credit control person, and of paying overdraft fees, and factoring just made more sense,” he continues.

He also says that one major worry attached to factoring – that your customers won’t like it – has not been a problem. “It’s not an issue for our clients,” he says. “Many of them are actually quite happy with it because they can just pay Skipton by BACS transfer rather than having to go to the trouble of raising cheques.”

For Wilkes the primary purpose of the facility is to smooth cashflow. He is hoping only to need the facility for 12 to 18 months (at which point he predicts £1 million turnover), after which he expects to be able to fund the company’s debtor book from its profits.

One company that has used invoice finance for a little longer than 18 months is Wigan-based Brick Store. This brick merchant, which sells around 20 million bricks per year, is, according to managing director Malcolm Graham, “a smallish business that carries a lot of stock”.

In common with many businesses, it has to deal with suppliers that require payment within 30 days while its customers, many of them national heavyweights, operate on 45-day terms.

Founded in 1990, the company had used a factoring facility since its earliest days. In April 2007 it decided to switch to an invoice discounting facility from Manchester-based City Invoice Finance. This facility enables the business to draw down up to 85 per cent of the value of its invoices up to a total of £850,000.

“Now we have control over our own credit control – and it’s cheaper than factoring,” Graham says. “Another reason for us going with City was that I liked the idea of them being local and having a small number of people to deal with – they’re just down the road so I can actually go and see them if anything ever goes wrong.”

Recruitment is another sector in which invoice finance has proved popular. Sean Hickey co-founded Marple Bridge-based CCS Recruitment 12 years ago. CCS, which has a projected turnover this year of £6 million, provides staff to the construction industry while Inspired Recruitment, a sister company founded six years ago, achieves similar revenues in the technical, engineering and IT sectors. Both companies provide contract and permanent staff.

Hickey used a £1.5 million invoice discounting package from Royal Bank of Scotland to part-fund a management buyout of the group last year – and has continued to use it for day-today cashflow management.

“We chose RBS because they understand the recruitment marketplace. They are very proactive and we get decisions straight away. There’s a relationship of trust.

“They audit our business, looking for good quality assurance and control systems, but the more they audit us, the less they need to, if you see what I mean.”

Although he says all his clients know about the invoice discounting arrangement, he still says, “Invoice discounting, as opposed to factoring, puts us in charge of our own destiny. We do all our own credit control – it’s us dealing with clients, there is no third party in the relationship.”

Hickey insures all his clients, so he won’t be left with a big bill owed to the discounter if any of them defaults. He says that while an overdraft might also provide cashflow smoothing, “with invoice discounting I can sleep at night”.

“Also, for an expanding business, it gives us leverage – we have cash, which we can use to fund growth and investment.” Another recruitment

specialist agrees that relationships are vital. Andrew Sawer, co-managing director of graduate sales recruiter Pareto Law, explains that his firm followed one individual across a number of lenders.

“He never asked us to go with him, but we trusted him,” Sawer explains. “Our concept is quite complex and we didn’t want to have to try to explain it to someone new.”

Pareto Law used invoice discounting from the firm’s earliest days in 1995 until about two years ago. Cashflow was always going to be a problem, he says.

“We gave clients an option to pay their fees to us over several months. Couple that with double-digit annual growth and the fact that every year we had more and more people working for us.”

Like Hickey, Sawer says his clients always knew there was an invoice discounter in the background but that it never caused problems. However, he was not tempted to go down the full factoring route.

He explains, “A lot of people were paying us by standing order anyway, and we didn’t want people to be chasing our clients. We felt communication with our clients was very important.”

Pareto Law normally discounted 50-60 per cent of its invoice totals although, he says, the lenders would have provided up to 90 per cent. The company now has enough money in the bank not to need any sort of finance facility, he continues, explaining that by the time the company gave up its facility it was as cheap as any other source of finance.

He says, “When we started the costs were higher, but we were able to renegotiate as our covenant got stronger. In the end it got to be comparable with an overdraft in terms of costs – and it was very useful to have flexible amounts of money available.”

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