What is invoice discounting and is it right for me?

Peter Brinsley, director of SME finance consultancy Point Forward, explains this finance option and how it could help your business with your international goals.

Invoice financing

Companies that are growing and possibly looking to sell overseas, either for the first time or moving into new export markets, will very soon discover that terms of trade outside the UK can be very different from the domestic market.

Here, sales are made on 30 or 30 days net, maybe 60 days at a push. Generally, the further south you go in Europe the expectation is that payment terms will be longer.

In Portugal or Turkey, for example, companies may demand 90 or 120 day terms (and sometimes even longer) simply because that is the norm in their own country. If your new customer is larger than you then you will probably find it necessary to meet those expectations.

This all puts pressure on working capital and that’s where invoice discounting comes in.

What is an invoice?

What is invoice discounting? How does it work?

Invoice discounting is the process whereby a seller effectively sells their invoices to a financier (discounter) as soon as they are raised and can receive payment up to 90 per cent of the invoice value within hours.

When the customer pays, you receive the balance that hasn’t already been prepaid by the discounter (in the case above this would be 10 per cent) less their fee. This fee, the cost of invoice discounting, is usually in two parts. First, a percentage of the value of the invoices (likely to be in the range 0.1 – 0.6 per cent), and second, a discount fee (think of it like interest) for the period between the prepayment and when the customer pays the invoice in full. This will be comparable to – sometimes less than – the cost of an overdraft.

Precise costing will be influenced by your forecasted annual turnover. Traditionally, invoice discounters have contracted with companies for their whole turnover (in other words, all the sales invoices to all their customers) but single-invoice financiers are becoming more common in the market. Their fees are usually higher, for one thing, because they cannot forecast how much business they are going to get in the coming year.

However, it’s a very useful source of working capital particularly when a business is faced with periodic demands on cash flow such as VAT liabilities.

How does it differ from factoring?

The great feature of invoice discounting is what makes it different from factoring – it’s confidential. That means, there’s nothing on the invoice to say you have sold your debts and also you keep the level of contact that you’d expect to have in a commercial relationship –  negotiating new contracts and collecting payment for current ones.

Why should I consider it? What are the benefits?

The cash flow benefits are obvious and you can use the cash you get “early” to service more or larger orders. You can now afford to buy in more stock for production or you could choose to negotiate a discount from your suppliers by paying them earlier than you usually do.

Unlike an overdraft, an invoice discounting facility is linked to your level of activity which is why it’s great for growing businesses.

Invoice discounting can come with credit cover too. That means if your customer doesn’t pay or goes bust you won’t suffer a bad debt. This is useful in your domestic market but even more so in export markets because it’s not easy getting good quality, reliable credit information on a new customer thousands of miles away and you can’t simply visit them to check them out. Credit cover gives you confidence.

You can read more about managing your representatives on Open to Export’s ‘Reaching Customers’ section.

What sectors/size business does it suit? How would I know if it’s right for me?

You need to have some track record in what you sell although you don’t have to have previous experience in a particular export market. Invoice discounting fits across many sectors, particularly where what is being sold (either goods or services) is “sell-and-forget”, in other words there are no (or very few) post-sale obligations on the part of the seller. It’s used by businesses of £100,000 turnover right up to tens of millions and beyond.

What are the risks?

The very real risk is trying to trade in new export markets on your own. Working with an invoice discounter can give a degree of comfort and some financial certainty at a time when you probably need that most. Read this article about the common issues you should be aware of in export for a more general overview.

Where can I go for more information?

The Asset Based Finance Association is the professional body that represents the industry with more than 45 members. Each of these finance companies works to ABFA’s code of conduct and thus acts with integrity, dealing fairly and responsibly, ensuring transparency of information and effective, timely client service.

You can also read more about how your working capital needs will change in this interview with Mark Emmerson of HSBC.

Topics: Credit Facilities, Finance, Insurance & Risk, and Payments
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