Tom Baker’s company is an extreme example of the cash flow challenge faced by growing businesses. Its products are in demand for just a few weeks a year and so the problem is even more acute – but it encapsulates the chicken and egg scenario.
“We don’t have much turnover between January and August – it’s a straight line,” says Baker. “Then we start delivering like mad, but unfortunately our customers don’t like paying within 30 days – it’s usually nearer 90. They’re keen to start receiving goods in September, but are unwilling to pay until December. This leaves us with a large gap between paying both our overseas and raw materials suppliers before we receive payment from our customers.”
When Baker launched the company, which now employs 35 people, he tried the obvious route of bank funding. But as is the case for many growing businesses, the company was considered too high risk to get the overdraft facility it needed.
“A turnover of £2m isn’t particularly well supported by an overdraft of £30,000, which was all I was offered.”
The answer to his problem was to look to invoice finance, in the form of factoring, in order to get the cash he needed for his company’s growth. “Our factor has been flexible, understands our business and works with us,” says Baker.
The arrangement is simple. The company is advanced 85% of the total of its invoices as soon as they are raised. His factor then takes on responsibility for collecting the money, saving him the need to chase the invoices. Once the debt is settled, the remaining 15% of the invoice value, less a service fee, is paid once payment is received. All but 1% of his invoices are covered.
Baker claims the Creative Christmas Company has been able to grow much faster than it would have done without the benefit of factoring. Last year turnover increased 25% on the previous year. “I’m currently sitting on £1m of stock, we’ll turnover £2m and will spend £500,000 in the next few months – thanks to factoring."
Baker acknowledges a lingering belief that factors are seen as a last resort funding route, but says this only applied to a minority of his customers. “The perception that factors work only with companies who are about to go down has changed a lot,” says Baker. “We still have a couple of customers who refuse to work with a factor, but most of our customers are happy and respect the professionalism in the industry.”
Seasonal companies aren’t the only businesses who turn to invoice finance for growth. Recruitment is an industry that commonly struggles to manage the gap between paying temporary workers who demand weekly wages from agencies, and clients who often take months to pay.
Jared Associates is a recruitment company specialising in the civil engineering industry. In a fast-growing sector, the company realised it would never be able to achieve its growth potential on its existing bank overdraft facility.
“The steadily increasing number of temporary staff was beginning to have a huge impact on our cash flow. We found ourselves constantly trying to renegotiate our overdraft facility to cater for our needs as an expanding business,” says finance director, Jonathan Chambers. ”The hassle factor was significant.”
Chambers considered persevering with the firm’s overdraft, but when its accountant recommended invoice discounting three years ago, he decided this would be a smarter option. “The most important aspect of our business is paying out a temporary payroll on time, cash transfer hiccups and last minute adjustments to availability would be very damaging.”
He says invoice discounting has smoothed out these bumps, making the monthly cash cycle run more easily. “Cash transfers are made on time and funds withheld on debts have been minimal. It’s given us a more predictable cash flow, enabling payrolls and other outgoings to be met without having to rely on our client’s promise that the cheque is in the post, while allowing us to expand the temporary staff base significantly. The overdraft route had limitations and attracting external finance would almost certainly have meant giving up equity.”
Chambers says the decision transformed the company’s ability to grow. “We now have 15 staff in our Tunbridge Wells office and have opened offices in South Africa and Australia. This is all part of our business plan to capitalise on the international migration of staff in our industry,” says Chambers.
The company’s turnover has also increased year-on-year and is expected to reach £4.5m this year.
Invoice finance is also increasingly used as an effective means of outsourcing the accounts department to minimise overheads. When Martin Brighty and David Walker launched a company selling handmade silk ties in 1996, this was a major benefit of factoring.
“To start a business in the UK you ideally need a year’s worth of money behind you. We needed £150,000 and we only had £1,000. When you’re new in business, banks don’t want to lend that amount,” says Brighty.
After exploring factoring as an alternative means of raising the finance, Brighty and Walker met with an advisor from Alex Lawrie Factors, who told them that if they came back with the orders, Alex Lawrie would come up with the money. They set off to the US, a market they identified as having huge potential, with some samples and, after securing £50,000, returned to a cash advance of £37,500 – 75% of the total outstanding invoices. So Hunters Partnership Ltd was born.
“We employed people who took four weeks to make the ties and a week later we had the money,” says Brighty.
Alex Lawrie now advances 90% of all Hunters’ outstanding invoices within 24 hours of them being raised, and the remaining balance is paid on receipt of payment.
“It works really well. We are able to outsource the whole credit control process to professionals. No security is required – we simply assign them the debtors ledger and they carry out credit checks on our customers. We can get credit references online within 20 minutes – the system is very streamlined,” says Brighty.
He estimates that factoring saves the company nearly £20,000 a year, compared to employing a credit controller, and believes that at least 30% of the working year is saved in terms of time spent managing and chasing debts. “Using a factor is nothing to be ashamed of. It shows we have the intelligence to outsource one of the most important parts of our business to professionals. We wouldn’t be in business without factoring.”
While Brighty’s point is fair, it’s a fact that corporate insolvency practitioners, in attempting to turn companies around, look to factoring as a means of introducing order to those who have let debt slip. For larger companies, the cash influx generated on invoices and assets is commonly used by turnaround specialists to bridge a shortfall, and put a company on an even keel while other changes are made to the business model. So, while such generalisations would be unfair, it can be suitable for struggling companies too.
As your business grows and evolves, invoice finance can also provide the most costeffective means of taking a new direction, whether to rescue a business or change tack. The management buy-out is a classic example.
When Sheffield-based sausage manufacturer Tranfield was being sold by its parent company in May 2003, its former managing director, Alastair MacDonald, was one of the management team keen to take control. The business has a turnover of £25m and employs 260 staff. However, the management buyout (MBO) team had one problem, they needed cash.
"We considered various options, such as mezzanine funding, but interest rates were high and you had to pay the money back at a certain time,” says MacDonald.
As a former finance director, he was familiar with invoice discounting and decided it offered the best route.
“It’s like a balloon – it inflates and goes down according to your requirements.” Through Enterprise Finance Europe, which MacDonald believed offered the most favourable rates, the MBO team raised £3m. This was based on the strength of the company’s debtor book, providing the chance to successfully implement the team’s strategic acquisition plan. The money was released on the agreed date.
“We could have carried out the MBO in other ways, but it would have meant getting involved with venture capitalists and things like that. By using invoice discounting we could retain control as well as using our own assets as opposed to someone else’s,” says MacDonald. “It gave us flexibility, which is the key to a new business because you never know what upsets might happen.”
Of course that’s also true of established businesses. When you are continually striving to anticipate market trends and opportunities to expand, risks have to be taken. But sometimes, as one printing firm, which prefers to remain anonymous discovered, they don’t always work out.
Producers of marketing collateral, this company had a steady growth rate and, in 2001, based on its expanding client base, it decided to move premises and invest in higher tech machinery. However, a subsequent downturn in the design industry meant the extra capacity wasn’t used and the anticipated growth didn’t materialise. “It left us with higher overheads without the accompanying income,” says one company director.
After going through a rationalisation plan it spotted an opportunity to increase turnover by producing print output directly to end users. It knew the company needed a funding solution to capitalise on this initiative and achieve an upturn.
“We had used another invoice finance provider in the past and understood the value the facility could bring.” As a result the company approached Enterprise Finance Europe (EFE) to support the trade cycle through the anticipated upturn and return the business to profitability. EFE provided £800,000 of refinancing based on the company’s biggest asset: its debtor book.
“It made complete sense to speak with debtor finance specialists to implement a facility that matched the fluctuating nature of the underlying asset,” says the director.
The company has since returned to profitability and has seen its turnover increase in recent months. "Without the flexibility that this facility offered we would not be making profits at this stage."
Everything you wanted to know about invoice finance but were afraid to ask...
WHAT IS INVOICE FINANCE?
Invoice finance is a flexible loan, based on your debtor book. As you issue invoices to your clients, an invoice finance provider will advance money to you, based on the sum of those invoices. For a growing business it’s a helpful way to overcome any cash flow problems. Providers lend you a percentage of the unpaid invoice before its paid, and the balance when payment is received, less fees. There are two flavours of invoice finance. The first is factoring, where you hand over your debtor book and credit control to your invoice finance provider. The second is invoice discounting, where you raise money against the invoice but still retain control of the relationship with your client.
WHO USES INVOICE FINANCE?
A lot of businesses. It’s one of the most popular and accessible forms of finance for growing businesses: 15% of all independently owned businesses now ‘sell’ their invoices as their main source of finance. In total, over 30,000 smaller businesses use invoice finance as a funding option, a number that rose by 10% between 2001 and 2002. Growth in the sector comes from the fact that invoice finance is now the preferred business financing option pushed by banks and a growing number of independent firms who offer the same service.
As Mark O’Neil, regional sales director at Independent Growth Finance points out, it’s increasingly difficult for small businesses to raise traditional forms of bank finance “without personal assets to pledge such as bricks and mortar”. The beauty of invoice finance is your debtor book is the only security you need.
HOW WILL IT HELP YOU GROW?
Quite simply, invoice finance unlocks capital due to you as soon as you raise an invoice. So instead of waiting 90 days for company A to pay you, while supplier X is demanding payment after just two weeks, invoice finance will bridge the gap, allowing you to fund sales growth and business expansion.
CAN MY BUSINESS USE INVOICE FINANCE?
To obtain invoice finance, your business must be raising invoices where the goods or services have been delivered prior to an invoice having been issued to the customer.
So which businesses aren’t eligible for invoice finance? Gerry Hoare, of Enterprise Finance Europe says: “Invoice finance suits business-to-business. If a company doesn’t operate on a ‘sell and forget’ basis – ie invoicing after providing a service or goods – you have to question whether the debtors will pay in an insolvency situation. If there’s an opportunity for dispute over whether the goods or service has been delivered, invoice finance may not work.”
According to research by the Factoring and Discounters Association, the UK industry body, over a third of all factoring clients are from the manufacturing sector, with services, transport companies and engineering also likely adopters.
While the invoice finance industry used to say that companies should have a minimum annual turnover of £80,000 to justify the fees involved, providers are increasingly open minded. Angela Harvey, of Alex Lawrie Factors, says: “If a business has a good idea and the only thing stopping them is cash we will try to help. We look at a business and the opportunities it has, whereas traditional providers tend to demand security and a track record.”
As a general rule of thumb, if your business sells on credit, has a good spread of debtors and boasts growth potential, you are likely to benefit from invoice finance.
While Ann Horan, chairman of the Factors and Discounters Association (FDA) points out that “the discounter will minimise risk by seeking to fund only companies that exhibit strong and competent management and have a good spread of debtors,” some providers will fund a business that relies on just a few clients.
HOW MUCH CAN YOU RAISE?
There’s no rule of thumb as to how much money you can raise. It will depend on your needs, the industry you work in and the strength of your debtor book. Invoice finance providers will typically start by advancing an average of 75% of your invoices and then, based on the credit worthiness of your clients and the strength of your business, this can grow to 95% or even 100%.
You also don’t have to hand over all of your invoices. “If a client only needs to fund a certain amount we will set it at a certain percentage. We remain flexible so that we can increase or reduce that percentage over time,” says Harvey.
It’s important you check what a provider is prepared to offer you and how flexible it is before you commit. “A business might sell £10,000 worth of goods to a customer and expect to be advanced £9,000, but if the credit rating of that customer doesn’t match, the provider might only be prepared to advance 50%.” The type of invoice finance will also affect how much you can raise.
FACTORING OR INVOICE DISCOUNTING?
There are two key forms of invoice finance: factoring and invoice discounting. Both work on the same principle, but factoring is a full service that allows you to effectively outsource your whole credit control function. Your factor will carry out credit checks on your customers and advance payment on your invoices, as well as managing your sales ledger and chasing late payment.
Factoring tends to suit smaller companies who don’t have a dedicated accounts department. “It takes all the hassle out of chasing payment, for a small percentage of the invoice value,” says Stuart Holloway, managing director of RBS Commercial Services. “We will tailor how we collect debt to the client’s needs, but the standard way is to send a statement one month after the invoice is issued, followed by a chasing letter, say seven days after the invoice was due, if it remains unpaid.”
Some factoring companies will only chase the invoices that hold the most risk, so it’s worth checking how many customers or invoices a factor will chase, as well as how it will be carried out, such as by phone, email or letter. You will need to make sure this fits with how your customers like to be treated.
Invoice discounting is a more basic service. You will retain responsibility for chasing late payment, while the provider will simply advance the money. This facility tends to suit larger companies who have an accounts department. “It’s not generally available for businesses with annual turnovers below £1m or those with a weak balance sheet,” says O’Neil. This is because the provider lacks the control that a factor has and therefore incurs more risk.
The downside of factoring – other than perceived ‘loss of control’ and cost – is often image. “When first used in the UK, invoice finance was associated with ‘last resort’ finance, mainly as a result of factors taking on too many unsound businesses. Since then businesses have worried that factoring may be seen as a sign of financial weakness," says O’Neil. Now, increased flexibility and product awareness, use of technology and greater competition have changed most people’s perception. Companies that use factoring do lose the personal interaction with customers, which many value. Clients must be happy to deal with a third party, which doesn’t go down well with every business. Invoice discounting is viewed more favourably, but some may still think it’s being used because the company is not performing properly.
HOW MUCH DOES IT COST?
This is dependent on your turnover, which provider you use and whether you choose factoring or invoice discounting, but it’s standard to be charged two fees: service charge and interest payments. Service charge is a percentage of your turnover and interest is based on the amount borrowed.
Generally, the smaller the company the larger the percentage of turnover charged. While factoring service charges will vary from 0.3% to 3%, charges for invoice discounting are more likely to fall between 0.1% and 1% of your turnover. Interest rates are likely to be between 1% and 4% over base rate.
“Ask yourself just how much time you spend chasing payment,” says Holloway. “If your turnover is £50,000 and you are spending time chasing debts when you should be making money. While the debt remains unresolved for longer and longer, you can either employ a bookkeeper for £15,000 a year or you can pay £4,000 to a factoring company.”
WHAT ABOUT BAD DEBTS?
You can protect yourself against non-payment by paying extra for a ‘without-recourse’ service, which insures your debts and means the provider will pick up the bill. Typically this will add no more than 0.4% extra to your annual service charge.
If you choose not to sign up to a ‘without-recourse’ service you will be expected to make good the bad debt to your provider costing you money and time.
“If your debtors are well spread and are low risk, you are less likely to need credit insurance, but even a portfolio of blue chip customers can cause problems. It’s always worth considering,” says Peter Ewan of Venture Finance. At worst your failure to collect debt could result in the collapse of your business, particularly if the debt that is bad is with one of your major customers.
HOW DO YOU CHOOSE A PROVIDER?
Don’t always choose the provider that will lend you the most money. “It’s the worst thing you can ask, but it’s often the first question,” says Holloway. “You need to know how reliable the factor’s systems are and how they will deal with your customers.”
You will also be talking to your provider everyday so ensure you feel comfortable with them and that they understand your business. Make sure they aren’t looking after so many clients that you will be just a number, and ensure that you will have fast, easy contact with the right person.
Before you sign anything, check the contract thoroughly. “Some providers stipulate that you only get out of the contract on an anniversary date – not one day earlier or later,” says Harvey.
While a provider might dangle a 90% advance figure in front of you, you must make sure there are no hidden restrictions, such as concentration of clients or credit insurance obligations.
