Having a 90-day gap between completion and receiving payment can place severe limits on growth. By releasing a little capital ahead of time, invoice financing can help ease the transition between the sales pitch and payday
Facing a hole in your cashflow is a daunting prospect and for good reason. “Waiting to be paid can be devastating,” says Christopher Shaw, CEO of alternative invoice finance provider Platform Black. And the impact this has on small- and medium-sized enterprises (SMEs) is disproportionate to their size.
Shaw argues that although many larger blue-chip enterprises will insist on immediate payment for their services they will often only pay suppliers on very long payment terms, improving their own cashflow to the detriment of small companies. “The effect on the SME can be devastating; it can slow up recruiting and expanding the business to deal with the orders coming in,” Shaw continues.
“As soon as you start issuing credit to people and selling to other businesses then you can be as keen as you like in managing your profit and loss account,” remarks Malcolm Durham, chairman of FD Solutions. “You can still go bust even though you’re apparently profitable because you haven’t managed your cashflow.” Obviously an entrepreneur must prevent this situation at all costs and there aren’t too many options available. “You have to bridge the gap in your cashflow by putting money in yourself, not taking as much out or getting it from somewhere else,” he says.
Traditionally enterprises would have turned to conventional lending to address the shortfall. “If you go back twenty years, the traditional overdraft would lend you some money backed up by your house and using your debtors as additional security,” comments Durham. But in recent times, in part – although not exclusively – down to the economic downturn, banks were forced to reassess their capital adequacy, meaning that traditional lending methods like overdrafts weren’t able to address the sums involved.
Shaw is eager to dispel the myth that this is down to unwillingness on the banks’ part. “In many cases they simply cannot help the SME because the profile of those companies don’t fit the type of debt that they can take on at the moment,” he explains. “This puts incredible pressure on SMEs and means they need alternative sources of finance.” And where can enterprises turn to release the sort of equity they needed? To the most logical place: the invoices themselves.
Releasing funds from accounts payable falls into two main categories: invoice factoring and the related invoice discounting. The two differ in terms of who retains control of the collected invoices – in factoring the debts are entirely sold off to the factor to release some 70%-85% of their value. By comparison, discounting merely uses the unpaid invoices as collateral for the short term loan, which is repaid once the buyer has paid the outstanding balance. But their main aim is the same, in that they help businesses release the potential funds locked up in their invoices
Durham feels invoice financing offers a better solution to address gaps in cash flow than other forms of lending. “Invoice discounting, and its cousin factoring, are a better form of borrowing to fund that gap,” he says. “The invoice discounter has a more active role in looking at your debts – the people who owe you money – and will lend you a greater proportion of that money as a result.”
Rather than basing their limits on the liquidity and value of the enterprise – which would severely limit its ability to scale quickly – the limits are based on the nature and reliability of clients. Durham explains: “They will look at the people you’re planning to sell to, see if they are credit worthy and give you a credit limit based on what that company’s results show.”
Invoice financing can help to address the issues that come with relying on credit to grow a business and meet increasing demand. “If my sales this month are £1,000, next month are £1,200 and the month after are £1,300, with an overdraft facility I might be able to borrow £600 this month and the same in the months that followed,” explains Durham. “But I’ve got another £300 of sales which need supplies that I have to finance.” Extending the business’s overdraft limit in this scenario could take up to three months, which suddenly poses a problem. “With invoice discounting and factoring, since it’s set as a percentage of my sales, my available funds have gone up from £800 to £960 to £1,040. So I keep getting enough cash in to be able to pay my additional costs.”
That’s not to say that invoice financing is entirely devoid of associated issues. One problem is that if firms find out their invoices have been sold or borrowed against, it can send the wrong message. “It can be thought of like giving it to a debt collector – people think if you’re selling your debts you must be in the last chance saloon,” Durham explains. “Neither of which is true.” Confidential invoice discounting (CID) can offer some degree of privacy but as the proceeds need to be paid into a separate account to your main BACS payments, it can still lead to difficult questions that could jeopardise your relationship with the buyer.
Something that could also potentially prove to be a significant issue for enterprises is that they retain little control over their sales ledger or which deals they borrow against. “In 98% of cases, they have to outsource their entire sales ledger to the factoring or invoice discounting company,” remarks Platform Black’s Shaw. “They basically have to hand over everything.” Up until recently there was little alternative for those who wished only to borrow against select invoices but now a new concept – invoice trading – has stepped in to address this.
Shaw’s solution, Platform Black, is effectively the first UK invoice financing marketplace. Not only can the enterprise involved pick and choose the specific invoices they want to borrow against but they are also able to set the terms that suit them, rather than it being fixed by the lender. “They do that by setting up an auction,” he explains. “They upload it into the platform and they will select two things: how much of that invoice they’d like advanced and how much they are prepared to pay for the privilege.”
“Somebody could come in and bid for the whole value or they could bid for a portion,” Shaw says. “The first part is getting up to 100% of the advance.” Perhaps what makes Platform Black so novel however is what happens next: lenders actually bid down from these terms. Shaw comments: “The next bid that comes might lower the amount the enterprise has to pay to 1.45% and then they go down in 0.05% amounts as low as the bidders will drive it. So it’s pushing down the cost of finance for the SME which is a brilliant way of giving these enterprises access to a competitive marketplace.” A measure of the Platform Black ‘entity-to-entity’ solution is that thus far every single one of its deals have not only secured their lending targets but have often also achieved better than requested terms.
Given the economic situation, embracing alternative methods of securing finance is more important than ever and companies could do far worse than turning to one of the biggest resources at their disposal. “Invoice finance just gives enterprises the most flexible and most cost effective method of alternative financing,” says Shaw.