5 things to consider when comparing factoring quotes

Invoice finance is a niche, over-complicated product!

It’s a fantastic cash flow solution when deployed correctly, but unless you know exactly what you should be looking for, you can easily get it wrong and end up with a funding facility that isn’t working as well as it should be for your business.

Unsurprisingly then, I would always recommend that you use a specialist broker to not only ensure you get the best deal, but the right solution for your business. Cash flow is the most important part of your business, so it doesn’t make sense to take a chance and try and work it out for yourself.

Let the experts take care of it for you, our services are usually completely free of charge anyway (we get paid a commission by the lender we successfully place your business with).

But just in case you do want to go it alone, I am outlining in this article the top 5 things to consider when comparing invoice finance or factoring quotes. I take a lot more than 5 things into account when I’m assessing invoice finance proposals for my clients, but this is a good starting point:

Product

First and foremost, what invoice finance product are you being offered?

Invoice factoring, invoice discounting or a full asset based lending package?

Selective or whole turnover?

In short, factoring will usually include some form of credit control and be disclosed to your customers, because they have to pay the factoring company directly. Invoice discounting, on the other hand, is confidential and your customers continue to pay you directly.

Asset based lending is generally for larger, more mature businesses and will include funding against your stock, plant & machinery or commercial property alongside your trade debtors (receivables).

Invoice finance can be provided on both a selective, or whole turnover basis.

If you’re using a selective facility, you can pick and choose which invoices you would like to factor whereas with a whole turnover facility you need to assign every single invoice to the factoring company (unless you have agreed to exclude specific debts).

If you have an ongoing, and increasing, working capital need then whole turnover is best. Selective is better suited when your cash flow requirements are more sporadic and it will typically work out more expensive per invoice than a whole turnover facility.

Fee structure

Most factoring companies will charge you a service fee on each invoice that you present to them for funding.

You pay this fee, which is a % of the gross invoice value, whether or not you actually draw down any cash against it.

The borrowing charge, or ‘discount’ as it is confusingly referred to in invoice finance terms, is applied separately on whatever your drawn balance is, daily (just like it would be on a bank overdraft).

Some providers now offer a fully inclusive fee, which is a bit easier to digest, but can be expensive, especially if you are not fully utilising the facility. A lot of the selective invoice finance facilities are offered on a simple, single fee basis.

Don’t just compare the headline rates, though.

The devil really is in the detail, and it’s important that you look out for additional charges like audit fees, annual review charges and minimum fees.

Advance rate

The main benefit of invoice finance is that you receive an agreed % of the gross value of each invoice you issue, within 24 hours of issuing it - meaning you don’t have to wait 30, 60 or 90 days to receive your cash.

The advance rate can be as high as 95% or even 100% but it is typically around 85%.

For some sectors such as construction, it is usually between 40% and 70% (you can find out why here).

But as well as being sure you are being offered a competitive advance rate, pay careful attention to any restrictions that will reduce the amount of cash that is being made available to you, such as -

Customer credit limits

Always ask the invoice finance provider to tell what credit ratings they have on your top 5 customers.

Their advance rate could be 300% but if the ratings of your top 5 customers are zero, you are not going to receive a great deal of funding.

Customer credit limits are really important because they ultimately determine how much cash is going to be advanced. They also, of course, give you a good indication of how credit-worthy your customers are, and therefore exactly how much business you should be doing with them.

Concentration limit

Most invoice finance providers will put a limit on how much debt can be exposed to a single customer - e.g. if the concentration limit is 30%, they will only fund to that level and anything above it will not be funded.

The concentration limit should never really be less than 30%.

Take into account your current customer spread but also consider what it is likely to be in the future. If, for example, you anticipate securing a large contract and your exposure to a single customer is likely to exceed 30%, you need to make sure you are choosing an invoice finance facility with a suitable concentration limit.

You can mitigate the risk of high involvement further with bad debt protection, which basically means that provided you trade within the insured credit limit, you are protected against losses as a result of customer insolvency.

Some invoice finance companies will actually insist on this if you are heavily reliant on a single debtor, and it is probably best practice anyway to protect your business.

Contract term

Some lenders offer very short contract terms of just one or three months.

The average term length is probably around twelve months, with a three months notice period (so the earliest point at which you could give notice would be nine months).

I don’t generally see a lot of value in a short term contract, because most of my clients consider invoice finance as at least a medium term requirement anyway. But an initial contract term of more than 12 months (and notice period of more than 3 months) should be avoided.

What is more important, in my opinion, is what the contractual terms around termination are.

If things don’t work out, you need to be sure that you can have a sensible conversation with the lender and be in a position to switch providers - but some will include hefty early termination penalties and make it very difficult (and expensive) for you to terminate and move on.

Always check the small print around termination.

Security

The standard security for an invoice finance facility is the invoice finance agreement and an all assets debenture (for a limited company).

Director’s personal guarantees can be required too.

I don’t actively discourage the signing of PG’s because frankly in many cases, providing one is the only way that young, growing businesses can access the cash they need to grow. And provided you trade honestly and sensibly, your personal exposure will be limited.

But never sign an unlimited personal guarantee! A personal guarantee should always be capped, and a good general rule of thumb is at 20% of whatever the facility review limit is.

Director’s of more established, mature businesses - certainly those with net assets of £1m+ - should only be expected to provide director’s PG’s in very exceptional circumstances.

So, there you have it - a quick canter through some of the key things to consider when evaluating invoice finance quotes or offers.

I’ve really only scratched the surface, which I think demonstrates just what value an invoice finance expert like myself brings to the table for business owners that are trying to navigate the market for the first (and possibly only) time.

If you would like help securing the right funding package for your business, please don’t hesitate to get in touch either by completing this form or by calling us on 0800 987 1010.