With hard times biting it's back to basics for asset finance

Whether we plunge headlong into recession or just teeter on its edges, there is no doubt that cash will be a critical factor for businesses for the foreseeable future. Banks are likely to be re-appraising the extent of loan facilities made to businesses, and finance directors can only try to have the best systems in place to survive and prosper in a challenging environment.

One financial product that always makes a showing during leaner times is invoice finance – factoring and confidential invoice discounting. “Already we are witnessing growth in the invoice discounting industry of between 12 and 14 per cent every year,” says Kate Sharp, chief executive officer of the Asset Based Finance Association. “Because it does what it says on the tin.”

In fact, some of the North West’s invoice finance houses say they have received up to 40 per cent more invoice discounting enquiries this year than in the three months before Christmas, many of which are from companies that have had funding refused by the
banks.

Andy Porter, managing director of Ultimate Finance in the North, says, “There is no doubt it is harder these days just to walk into a bank and obtain the funding you require, and banks are definitely less willing and also less able to complete the transactions.

“As a result we are now seeing a drip-feed of these better-quality leads that six-months ago would be snapped up by one of the top four banks.”

Indeed, the reason for the popularity of invoice financing is simple. Businesses often get into difficulty because of a lack of cash, not a lack of profits. Without cash, workers can’t be paid, raw materials can’t be purchased and a business ultimately can’t function.

One of the simplest steps to keep cash flowing is to keep on top of your invoices and credit control; and that is, essentially, what an invoice discounter does.

Invoice discounting comes in two flavours. The first is disclosed factoring. The second is undisclosed, and is known as confidential invoice discounting, or CID.

Most companies prefer CID and, even though it doesn’t suit all industries, it is now generally available across the market from an assortment of bank-owned and independent providers.

Both factoring and CID require a company to sell its debtors to the funder in return for an advance of anything up to 85 per cent of the face value of the debtors sold, with the balance, less charges, being paid on receipt of the cash.

With CID, the company keeps control of its sales ledger; with factoring, the factor collects the sales ledger – acting as credit controller for the client. Often confidential invoice discounters will offer additional funding, secured on stock, plant and equipment or on factory or office buildings.

But there is a stigma attached to invoice discounting and factoring by those who see it as a tool only for businesses trying to dig themselves out of a deep hole. But Sharp says the idea that invoice discounting is only a lender of the last resort is out of date.

“Years ago people were wary of it, they thought companies only used it when they were going bust. That’s changed now,” she says.

“If a bank manager says he can’t help you beyond a tiny overdraft and an invoice financier agrees to help you more than that, is it a lender of the last resort or a business angel?”

The providers of the products in question say asset-based finance packages have a significant advantage over loans and overdrafts: namely that they grow with a business. Through these packages, a bank or other lender will advance cash against the assets already held by a business. Finance can therefore be provided against property, land or – more significantly for seasonal businesses – unpaid invoices and reserves of stock.

Sharp says: “Banks look at history, at how much the net worth is and how much the profit is, and then they decide how comfortable they are with it.

“An asset-based lender looks at the balance sheet but not at net worth and not at the profit. It looks at the asset value and makes a decision. The asset-based lender is coming from a different place entirely.”

Or, to apply the EN translator, it’s a good option if your P&L and net asset base look too flaky for a mainstream lender. We still appear to be in “lender of last resort” territory here.

However, Alison Small, managing director at Manchester-based City Invoice Finance, says invoice discounting can be better than bank overdrafts for financing in the short and medium term because, from the client’s point of view, it’s more flexible and confidential and allows a business owner to remain in control without having to offer personal guarantees.

“We are looking at the debt as security rather than asking for personal security which is likely to be attached to an overdraft. That’s preferred by the directors and the shareholders.”

Tim Rigg, head of commercial business for Bank of Scotland Corporate in the North, says invoice discounting should be treated as a practicality for many fastgrowth businesses. “When businesses are charging out new sales invoices, with an overdraft they would have to go back to the bank every week. A discounter will look at sales for the year and allow you to trade up to that lend.”

But flexibility comes at a price and getting someone to tell you outright how much an invoice discounting service will cost isn’t easy.

“People think it is always going to be more expensive, and often it is,” says Yvonne Halliday, manager of funding solutions at accountancy firm PKF. “But it’s a lack of understanding about what they are buying.”

While a bank will set a fee for arranging an overdraft and charge interest, an invoice discounter will offer different packages depending on the circumstances of the client.

Sharp says, “Do you want them to collect? Do you want information on customers and insurance against bad debt? If you want the full factoring package it will be more expensive. But if you just want an invoice finance deal, it’s hugely competitive with the banks. You won’t pay any more than you would for an overdraft.”

Costs vary according to your size, turnover and risk rating, explains Small. “It’s the same as an overdraft facility in that way. Obviously, if you can operate your business in credit then invoice discounting is expensive but if you are borrowing money it is very cost-effective.”

We have highlighted the above as it sums up the entire issue for SMEs.

Charges on invoice discounting are split into cost of money, known as a “discount charge” (effectively interest), and a service fee. The service fee can be between 1.5 and three per cent of turnover. The discount charge can vary from 1.5 to 2.5 per cent over the current bank base rate.

While invoice discounters have traditionally agreed to lend between 70 and 90 per cent of the value of the debtor book, some, like the Bank of Scotland’s invoice finance arm, have moved to offer 100 per cent as a way of targeting better-quality business.

Rigg says, “Those clients should have a good debtor book so we know there won’t be any comeback and we will get 100 per cent back.”

There is also a preconception that once a business has started using invoice discounting it will be stuck with it for life.

A relationship between invoice discounter and client will actually typically last around three years and an invoice discounter should prepare a business to take over its credit management role before the contract expires.

Graham Cooper, from invoice financier Bibby Financial Services, says, “Some companies will always use it. Some just like it because of the convenience, while some want access to every penny available to them.”

A service contract can be limited to one year or as long as three years but such contracts can cause a problem if the service does not bring the benefits you expect, or if your business changes course, or fails to achieve your expectations for growth.

Cooper says, “We have had clients for 18 years or longer but that’s unusual. Clients might move on, some might outgrow the facility or we might get them to the stage where the bank will give them an overdraft. Others become cash positive. They generate sufficient cash flow and can carry on without us.

“But some just like the services we provide. They are sales-focused and they want to spend their time on that.”

Invoice finance can, its proponents say, also provide the most cost-effective means of taking a company in a new direction. The management buyout (MBO) is a classic example.

When the owner of Accringtonbased Straits Trading Company wanted an exit, Paul Aspin, as finance director, led an MBO that was partly funded by invoice finance. This saw him and managing director, Marvin Lomax, acquire controlling stakes in the business from Garland Whalley & Barker, a Yorkshire-based private investment company.

Aspin says Straits had already used invoice finance through its previous bankers and was keen to take advantage of the increased level of lending against invoicing on offer from The Royal Bank of Scotland.

He says, “I’ve worked in a number of businesses where sales finance has been used. Where cash flow can go in roller coaster cycles,it’s a very good tool to support your troughs.

“At Straits we have high periods of funding requirements and low ones. Rather than having a loan, you can use sales finance to manage that and the charges will be less. And you can draw down funds as you require them, so interest charges are significantly less.”

Alison Small says, “Using invoice finance, a business doesn’t have to give as much to venture capitalists, for example. They can retain more themselves as directors and shareholders. For a buy-out, you are providing head room in the business so there is more cash flow availability for unexpected eventualities, which are very possible in a deal of that sort.”

Providers believe the interest in invoice discounting is yet to reach its peak. They say the proactive approach taken by businesses that have already investigated invoice finance as a potential tool will prepare them for the worst – if their overdrafts are withdrawn or they run into financial difficulty.

For those less prepared, the message is to move quickly before the need to raise finance becomes critical. Halliday says, “Don’t leave it too late so you are forced into a Hobson’s choice decision.”

---