Anthony Cork explains how invoice financing can benefit your business.
The number of construction companies using invoice financing has jumped by 17% in the last year following a decline in traditional bank lending. Between July 2011 and July 2012 the numbers turning to this type of finance grew from 1,629 to 1,911, according to the Asset Based Finance Association.
Cash flow is critical to construction companies and invoice financing can help bridge the gap between raising bills or applications for payment and getting paid.
Under the system, businesses assign their sales invoices to an invoice finance provider, which then pays a significant proportion of the value in cash. The remaining balance, less the provider’s charges, is then made available to the business once the debt has been collected.
By factoring in this way, businesses gain the additional benefit of a comprehensive sales ledger management, credit control and collections service, freeing them to focus on their core business activities. On a long-term construction contract, a contractor doesn’t necessarily raise an invoice as it goes along. Instead, it might make an application for payment (to get the money quicker), which can be certified by the surveyor. A physical invoice is then raised at the completion of the work. Some invoice finance providers will even make funds available against uncertified applications for payment, unlocking valuable cash flow to a business rather than facing delays while they wait for applications to be certified.
As well as closing the cash flow gap between making a sale and receiving payment, using an invoice finance facility enables a business to treat invoices as a tangible asset with an immediate realisable cash value and take advantage of preferential early payment discounts with suppliers.
It also helps identify the early signs of payment problems to minimise bad debts.
However, there are several things that a company considering using an invoice finance facility should bear in mind.
First, businesses need to make sure they understand the various charges associated with an invoice finance facility. Invoice finance providers will tailor the cost of an invoice finance facility to a business’s specific area and requirements. Typical fees charged by lenders include:
- Arrangement Fee This is a fee charged to cover the due diligence on new clients.
- Service Charge Fee This is a fee that covers the ongoing servicing of your facility and will vary according to the value and volume of invoices you put through.
- Discount Charge This is a percentage charge above the base rate or LIBOR, calculated daily on the money drawn down from your facility.
- Legal Costs This is a cost for putting the facility documentation in place and may include the cost of preparing and registering a legal charge over your business.
Second, businesses need to understand the difference between recourse and non-recourse factoring.
Recourse factoring does not include bad debt protection, so if a customer fails to pay an invoice that has been financed then the invoice finance provider will look to the company to repay the finance on that invoice.
Non-recourse factoring includes bad debt protection, so should a customer fail to pay an invoice then the invoice finance provider will credit you with the amount of the debt. This type of facility will be subject to a customer receiving credit approval and subject to certain agreed credit limits.
Businesses will also need to have a firm grasp of “approved debts”. These are debts which an invoice finance company is prepared to finance. Disputed debts are not normally approved and many invoice finance providers will not consider funding invoices that are greater than 90 days old.
Finally, business directors will need to be ready to provide a personal guarantee. In addition to taking security against your business such as a debenture (registered at Companies House incorporating a fixed and floating charge), an invoice finance provider may require the directors to provide personal guarantees. If the invoice finance provider fails to recover the money owed to it under its security against your business, it will look to the directors to cover any shortfall under their personal guarantees.
Anthony Cork is a partner at Wilkins Kennedy, tel: 020 7403 1877 [email protected]
