Factoring – expensive and confusing?
How many times have you heard the comment “Factoring is expensive! Too many in my opinion. What concerns me is how many businesses are failing to take advantage of the benefits that Invoice Finance could deliver to them because of an uninformed comment.
When a business is seeking out the right funding solution, they may be looking at a range of different funding options for their business and there will be many criteria that they will be using to determine which one is best for them – price being one. But when looking at the price of funding it’s important to ensure that you are comparing apples with apples otherwise your decision-making process may be flawed.
Most people compare the cost of Invoice Finance with a bank overdraft, but this is not like for like. Invoice Finance provides greater flexibility in terms of the amount of funding you can access because it’s based on real time turnover and not historical management or audited accounts. More importantly though, Invoice Finance may include a professional outsourced credit control and sales ledger management service which provides internal cost savings and frees up management time to focus on developing the business. It is important that the business weighs up the costs of the facility versus the benefits it delivers when deciding on the right type of finance for them.
One key benefit that Invoice Finance delivers is improved cashflow which can mean that the business saves money by opting for early settlement terms with their suppliers. Whilst the credit control and sales ledger management service can also improve debtor days releasing cash into the business more quickly, which makes the facility cost effective. For example, a 4-day reduction in average debt turn will release over £10k back into working capital for a business turning over £1 million over the course of a year.
Another comment I often hear is that “the fees are complex and confusing”. We have all heard feedback from businesses that think the way the industry charges their fees can be confusing. I would suggest that this is because they aren’t explained clearly upfront whilst checking the client understands what they will be charged.
There are two standard fees – the cost of finance and a service fee. The cost of finance –also referred to as a Discount Fee, is typically expressed as an annual percentage over Base Rate and is charged against the actual funds drawn. Please check which Base Rate your lender uses as whilst it is fair to assume that it is the widely quoted Bank Base Rate, this is not always the case! This charge should be calculated on the daily outstanding funds in use figure. The discount fee typically ranges from 2% to 5% above Base Rate, although it can be higher or lower depending on the specific circumstances.
The service fee covers the administrative costs associated with managing the invoice finance facility. It is usually charged as a percentage of the total invoice value or as a fixed monthly fee. The service fee can range from 0.5-3% of the invoice value.
Businesses need to make sure that they understand the total cost of finance by asking what fees they will incur before they embark upon this route of facilitating cashflow. In addition to these two fees, there may be further fees added for other services provided – such as credit checks and faster payments - so it is wise to find out exactly what is included within the facility and what is not.
So, when businesses choose a new funding solution my advice is that firstly they choose a funder who takes the time to explain how the facility works and the costs involved so that there are no surprises. Secondly, they should always compare offers from the different providers, carefully reviewing the terms and conditions so they understand what they are getting and how much physical cash this facility will generate. Finally, don’t buy purely on cost alone, consider the overall benefits that a facility can deliver to the business.
