Invoice finance – Things to Watch out for
Invoice financing is a service that allows businesses to sell invoices to a third party company who process the invoices giving businesses the opportunity to draw loans against the money owed.
This form of financing is generally used to improve cash flow but is also a more secure way in which to reduce administrative overheads.
However, as with all financial tools there are potential pitfalls that need to be factored in to your decision making.
When considering invoice financing you should be aware that lenders set limits on the money they advance. This generally ranges anywhere between 50-95%.
The advance rate is largely affected by the credit rating of the businesses customers. If the credit rating is poor then the advancement would be lower as the risk is greater.
Some third party companies will only offer a low advance limit, irrespective of customer credit ratings. Therefore researching a suitable lender is highly advisable.
There are two costs associated with invoice financing. The first is the service fee that is payable monthly to the financing company. This fee is due even if the service is not used.
The second associated cost is the discount rate. This is the percentage that the customer is required to pay when they draw down cash from the lender.
It is important to ensure that the minimum fees are reasonable and competitive. It is advisable to contact an independent broker to source the best deal. Most brokers will have access to special offers and preferential rates.
Insurance customers tend to invest in credit protection to cover themselves from bad debtors, i.e. a company going out of business and owing them money.
Most financing companies provide credit protection as a ‘bolt on’, however many third party companies offer cheaper credit protection. It is advisable to contact an independent broker who can research all options in the market.
Potential customers should be aware that there are varying contract terms for invoice financing. They usually work on a twelve month basis, although some lenders do offer 28 day notice periods and the option to terminate after 6 months.
When considering invoice financing the length of the contract should be carefully considered. The main issue with a short contract is that the lender can also terminate after the agreed period, not just the customer.
As with most forms of financing it is standard practice to have set up fees included in the contract. Many lenders have large set up fees in order to offer low monthly payments.
The main issue with meaty set up fees is that financiers can use this to their advantage by offering a smaller set up fee in exchange for larger monthly payments.
The points above have outlined the likely pitfalls of invoice financing and should be considered before signing any contract. It is advisable to contact an independent invoice finance broker for advice as they will be able to source the best deal on an individual basis for your business.
About the author: Touch Financial is an independent factoring broker, working with over 20 of the UK’s leading factoring companies.