Freed-up funds ensure wheels keep turning
Tuesday, September 1, 2015
"We would never have considered it 10 years ago, or even five years ago.” This single sentence from Linney Group managing director Miles Linney sums up just how much things have changed in the receivables finance game.
Because – you guessed it – Linney and his team at the £80m group are now operating, very happily, with a confidential invoice discounting facility.
So what has changed? Whether it’s factoring or invoice discounting, or newer options that have come to the market such as selective or spot invoice discounting (see below), these methods of keeping the money merry-go-round turning smoothly are worthy of investigation.
Lee Baty, head of trade and receivables finance for business banking at HSBC, acknowledges that factoring was at one time perceived as “the lender of last resort”. But he believes those sort of views are very much a thing of the past.
“That’s changed and the industry has changed significantly,” he says. “Factoring has been in existence for more than 50 years, and it’s gone through quite a journey.
“Nowadays we tend to be at the forefront of working with growing businesses. Forward-looking entrepreneurs look at it as a way of funding rapid growth,” he notes.
The biggest growth area is in invoice discounting, which Baty says is growing at some 8%-10% per annum compared with around 2%-3% growth for factoring.
In this era of the start-up, receivables finance also has appeal for companies that don’t necessarily have much in the way of traditional assets, such as plant and buildings, which could be used to secure finance. Instead they can leverage what they do have.
“Because it’s linked to sales, firms are able to harness and utilise what is the biggest asset on their balance sheet, the sales ledger,” Baty adds.
A huge number of UK businesses have already embraced receivables finance in one form or another. The Asset Based Finance Association (ABFA) estimates that, at any one time, in excess of 44,000 companies are receiving more than £19bn of funding via this route.
And this looks likely to increase, when a ban on restrictive clauses in contracts comes into force early next year.
At the moment, some companies have clauses in their terms of business that have been put there to prevent suppliers from sub-contracting work. The unintended consequence of such clauses has been to block firms, particularly SMEs, from using invoice finance.
Small business minister Anna Soubry has hailed the upcoming change. “By scrapping restrictions on invoice finance, thousands of firms across the country could benefit from faster access to hard-fought funds,” she stated.
And the Federation of Small Businesses (FSB) also welcomed the move. “The decision to outlaw the ban on terms in contracts to prevent businesses from choosing who they want to go to for invoice financing is overwhelmingly positive for businesses,” says chairman John Allan. “It’s something the FSB has been calling for and will empower businesses to take more control of their finances.”
The government-owned British Business Bank has also committed £45m to three providers of invoice finance to smaller businesses.
Need to know
What should print bosses take into consideration, then, if they are considering taking the invoice finance route?
The number one piece of advice is that it’s vital to take time to investigate the different options, and providers, thoroughly. “Some people just get three quotes and then pick the cheapest. This is not the right way to go about it,” notes one finance expert.
Nick Hood, business risk adviser at Opus Business Services, says: “The single most important step, which must be taken by enterprises proposing to go down this route is carrying out thorough due diligence on the prospective lender. Just like bringing in outside equity investors, there needs to be a cultural fit and a clear understanding of how the new lender will behave – not just when things aren’t going well but also, almost more importantly, when they are going too well and facilities need to be hiked in a hurry.
“No borrower should sign on the dotted line without having spoken first to others using the same lender, preferably ones independently identified and not provided as a ‘friendly referee’ by that lender,” Hood states.
Equally it’s just as important for printers to make sure their own house is in order.
“Companies should be aware that they will be audited, so their internal processes and documentation need to be up to scratch. Some companies struggle with this when they start factoring or invoice discounting, because they’re not necessarily used to this level of oversight,” notes Catherine Barnett, associate director at Grant Thornton.
Some printers might currently operate in a way whereby invoices are raised prior to the job being delivered. This sort of set-up will not be allowed under invoice discounting. And printers who hold stock for clients will also need to be upfront about that with their funder.
Importantly, invoice financing is unlikely to be the right solution for loss-making businesses looking for a lifeline to keep the business afloat.
“If a customer is losing money then receivables finance is not a solution,” asserts HSBC’s Baty. “If anything it will just impose additional costs. If sales and profits are in reverse, receivables finance is not a long-term solution.
“Will cashflow help them grow, or is it a sticking plaster to stop them running out of cash? If they are running out of cash, is it because they are growing or because they are loss-making and struggling?” he adds.
The upside is, that if a company is growing and creating sales, then invoice finance will support them through that growth. “Receivables finance allows the cash to flow through the business and grow with the business, whereas an overdraft won’t,” he adds.
This was one of the aspects that appealed to Linney Group, which had previously operated with an overdraft facility.
“When we looked at our banking in the old days, it was mainly a straight overdraft at ‘X’ per cent over base rate. Then when the banking crisis happened banks started to put restrictions on the amount of exposure they could have at any one time. This was forcing them to find alternative routes other than straight overdrafts,” Linney explains.
“In the meantime, the banks have made what used to be called factoring more attractive, and called it confidential invoice discounting (CID). So we looked into it, carefully, and we realised that lots of companies we know and respect were already doing it.”
The group signed up for its CID facility with HSBC in October 2013.
“The arrangement fees were pretty good and it saved us about 15%-20% at the time compared with the overdraft. The facility gives us the flexibility to grow and move quickly on things. It’s very useful to have that headroom if you are a growing or seasonal business. With just a phone call I can ask to move it up, if needed, and get a quick response,” Linney says.
“You do need to look into it thoroughly and make sure you understand it properly. There was time involved in getting it sorted out, but after that it’s been smooth.”
Understanding the fees involved is, of course, essential. Grant Thornton’s Barnett notes that this can be an issue. “One of the things that perhaps puts people off invoice discounting is that the fee structure can be perceived as complicated – with service fees, arrangement fees, and termination fees it can look that way. Some lenders are addressing this by wrapping it up into a monthly fee to make it more straightforward.”
HSBC’s Baty says that fees are based on the workload involved and the number of services taken – for example bad debt protection, or a facility that includes international trade. He says the cost will typically range from 0.5%-3% of turnover.
“It’s got to be more cost-effective than employing staff and re-arranging overdrafts constantly,” he notes.
There is, though, one very important potential issue with this sort of facility that every print boss should consider. What if sales don’t grow month-on-month?
Paul Holohan, chief executive at Richmond Capital Partners, warns that he has seen print companies fail precisely due to not preparing for this eventuality.
“Yes, if you are growing every month then you’ve always got drawdown. But if you have two bad months and as a result your drawdown has halved, your working capital will dry up. How will you meet your commitments if that happens?”
As Holohan points out, any business can have a couple of bad months, through circumstances that may well be entirely beyond the company’s control – just think of the impact of ‘black swan’ events such as 9/11 or the financial crisis.
For this reason it’s important to consider how the company would cope in such a situation. “Do a cashflow forecast and work out what would happen to your working capital if you have two bad months,” Holohan counsels. “I’ve seen a lot of businesses where the directors have had to put cash in, or re-mortgage their houses, to meet the needs of the business.”
“He’s dead right,” adds Linney. “A safety net is important, and we still have a small overdraft for that very reason.”
It’s also important to consider the small print carefully. One print boss found himself in a pickle after discovering that he had unwittingly signed up to a personal guarantee tucked away in his contract.
And if circumstances at the company change for any reason, it’s important to communicate that immediately to the funder. “Directors need to be open and upfront. Where we find some companies coming up against issues, it is where something has changed or become more complicated in the business,” notes Barnett.
Another common lament with invoice discounting is that the expected drawdown rate does not match the actuality once the facility is up and running. A firm might sign up expecting 85% drawdown, but this then turns out to be more like 58%, leaving a big hole in the company’s cashflow.
Problems like this can be avoided by providing a snapshot of the debtor book to the finance firm at the planning stage.
“It’s easy to quote headline rates, but the key driver is debtor quality,” says Baty. “We do a detailed analysis beforehand, because we want to make sure it will work for the customer and for us. There will be limits attached to individual customers,”
By exploring all these aspects thoroughly in advance, printers can avoid potential pitfalls and enter into this sort of deal with a clear understanding of the parameters and the expected benefits for the business.
If it is the right fit, all parties will be happy with the outcome. Linney certainly is. “All in all, it’s been a wonderful product for us. We challenged our perceptions and changed our minds about it.”
Nick Hood is a chartered accountant and former insolvency practitioner. He is a business risk adviser with Opus Business Services, which provides business advisory and restructuring services.
“Receivables finance can be the ideal funding method, especially for growing businesses or those with a need for extra cash for an investment project. It is far more flexible than traditional business lending and may not necessarily be more expensive. There are of course drawbacks, but provided business owners go into such arrangements with their eyes wide open and without unrealistic expectations these can be managed.”
Cash tied up in debtors is released within 24 hours, rather than being tied up for 30/60/90 days or even longer
This helps cashflow; suppliers can be paid on time, better credit terms negotiated and larger volumes can be purchased at lower prices taking advantage of bulk discounts
Invoice finance is flexible, growing as a business expands and avoiding the painful process of constantly renegotiating overdraft and loan facilities from traditional lenders
If credit control and debtor collection responsibility passes to the invoice funder, this will release management resource to focus on running the business
Credit checks on customers by the invoice funder can avoid potential bad debts and slow payers
For those using non-recourse invoice funding, the bad debt risk passes to the invoice funder, although the cost will be higher to reflect this
The drawdown percentage agreed with the invoice funder never matches the actual drawdown percentage, which is reduced in the real commercial world by disallowed invoices or customers and by late payment of invoices by customers
One or two bad months’ invoicing can create an instant hole in cashflow, which is difficult to claw back
Where the invoice funder is responsible for debt collection, there is potential for damage to customer relationships if their procedures are heavy handed
Costs can be higher than traditional bank finance, although true comparisons can be difficult
The small print, where some invoice funders bury the bad news such as hefty exit fees or personal liability for directors if the company enters formal insolvency
Lingering prejudice against businesses using invoice funding as a last resort in times of financial trouble. Dinosaur attitudes, but sadly not quite extinct
TYPES OF RECEIVABLES FINANCE
Sometimes known as ‘full service factoring’, this option is described as the complete answer to slow-paying customers and shortage of working capital. Bad debt protection can also be included as an option. The factor pays an agreed percentage of approved debts as soon as debts are notified – 80%-85% is typical. The factor also undertakes all credit management and collections work, to an agreed credit policy. “The savings in administration are substantial, and faster customer payments mean a reduced term of borrowing, resulting in lower costs,” says the ABFA.
Charges are commonly between 0.75% and 2.5% of turnover, plus a discount charge calculated on the day-to-day usage of funds that is “likely to be comparable with normal secured bank overdraft rates.”
This option is pitched at companies that want to generate the maximum working capital from the sales ledger balance, and already have the staff and systems in place to handle their own collections. Some firms simply prefer to handle that aspect of their client relationships.
Bad debt protection could be included as an option, and some providers will allow companies to use the service for export sales.
Charges may be a flat monthly fee or a percentage of turnover. “The fee will commonly be around or lower than 1% of turnover,” according to the ABFA. As with factoring, the finance provided in advance of collections is usually subject to a discount charge.
Spot factoring or selective invoice discounting
This is a relatively new type of product that may not be familiar to many printers. It allows companies to draw down on a single invoice for a one-off fee, rather than involving the whole sales ledger and being tied to an annual contract.
Selective invoice discounting is a highly-flexible option that can be used time and time again, and is potentially useful for companies that experience seasonal fluctuations in cash flow, or for instances where there is a single large debtor.
New online peer-to-peer finance platforms, such as Platform Black and MarketInvoice, have sprung up to service this niche.