Using factoring and invoice discounting to smooth cashflow and fund growth.

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 assetbased
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 at which 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 AIMlisted 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,” he says.

Sumner set up one of the UK’s first invoice discounting, as opposed to factoring, businesses for US Bank Boston Financial – a business which was acquired by Lloyds TSB in 1987. He says, “Confidential invoice discounting is suitable to a much more varied group of businesses because they like handling 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, “But 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.

Feba Custodia, a Sheffield-based security and facilities business due to celebrate its second anniversary in January 2008, has used factoring since day one and signed up this September for a new facility with GMAC – the US-owned former finance arm of General Motors, which was recently hit hard by the sub-prime crisis across the Pond.

Feba Custodia, which according to finance director Marie Ross has a £5.5 million turnover, factors all its invoices. She says that clients have, thus far, not expressed any doubts about dealing with a third party.

“I think factors have improved nowadays to the point where people don’t fear them,” she says.

The business uses factoring primarily as a cashflowmanagement tool. “We have a weekly payroll and have had to guarantee to pay the independent security offices we employ there and then,” Ross explains.

She says that, while the facility carries a higher headline cost than a standard overdraft, “It is more efficient – it takes the workload off my hands.”

That said, she hopes to move to a confidential invoice discounting facility in around two years’ time, and take credit control in-house. So can she foresee a time when Feba Custodia doesn’t use any kind of invoice finance?

“No,” she says. “I just like the fact that you send your invoices down and get some money there and then.”

For Technical Transport Solutions, a Bradford-based transport consultancy and employment agency founded in 2001, factoring isn’t just a cashflow tool – it has also used its facility of four years’ standing from IGF (part of the Greater London Enterprise Group) to fund investment.

Founder and managing director Kevin Brayshaw does tell EN that the company, which turns over almost £1 million, now factors all its invoices because, like Rotherwood, “For our recruitment side we need to be able to lay on enough money to pay wages in a seven-day cycle while invoices aren’t paid for 30-90 days.”

However, he also says the facility has been used to support growth and investment – something that would have been much harder using, for instance, a traditional overdraft.

“If you suddenly get a spurt of growth you have to go back and negotiate another overdraft,” he says. “But we have used factoring to fund growth, including the purchase of trailers for our haulage operation.”

He warns, though, that all factors are not equal. While he can’t speak highly enough of IGF, he says the relationship with the factoring company the business had used for the three years beforehand (it has used invoice finance almost since inception) was not so happy.

“They just never came up with the goods properly, didn’t do what they said they would and would withhold money on invoices,” he says.

Invoice finance is particularly popular in the recruitment sector, and someone else who has used it for a long time is Dennis Pagdin, senior partner at Keighley-based Rotherwood Recruitment. Founded by Pagdin in 1976, Rotherwood has satellite offices in Leeds and Burnley, Lancashire. It turns over in excess of £6.5 million and last year reported pre-tax profits of £590,000.

However, Pagdin explains, “We employ up to 500 people a week, and they have to be paid – while others don’t necessarily pay us as quickly.” The business began addressing this with a factoring facility back in 1994 – at which time, he acknowledges, the company would get “the odd problem” with customers who did not like dealing with a factor.

Since June 2003, however, Rotherwood has used a confidential invoice discounting facility from Skipton Business Finance (SBS). Using this facility the company can draw against up to 85 per cent of issued invoices.

Customers make payments to SBS – Pagdin says they have a “joint bank account” – but Rotherwood carries out its own invoicing and credit control. He won’t be drawn on whether, in a sector like recruitment, being able to take a softly-softly approach to credit control oneself is preferable to leaving clients to the tender mercies of a factor, but he does say, “If there is a problem and a client queries an invoice I can deal with it straight away.”

What about using invoice finance to fund investment in a similar way to Kevin Brayshaw? Pagdin says he has no such plans: “The facility is there for us to use as
we want, but as far as we’re concerned it’s there to do a job, plain and simple.

---