What lurks beneath – the hidden dangers of invoice finance
In my many years of experience in this industry, and having done many such deals, I have become quite blasé about invoice finance deals. I have learned from mistakes about how careful you should be to ensure that the total costs are understood, and what value for money you should expect. Throughout my career, I have also had the incredibly valuable experience of paying to buy my own company out of a less expensive invoice finance deal (in service fee and interest charge % terms), to go into a dearer one because the latter was not so administratively burdensome. This allowed me to get on with developing the business without onerous reporting, and was a salutary and expensive lesson.
What is constantly apparent to me now as I speak to recruiters, is that newcomers and even long term recruiters are often unaware of what service they are actually getting and what costs they are actually paying. Perhaps not surprising when they only go through the buying process once or twice in their careers and never experience the alternatives. In addition, my work has also put me in the unique position of being able to collate the comments of hundreds of temp agencies who have used factoring over the last 15 years, so it gives me a chance to share some information and what to look out for . That’s what I’ve done for you below, and I hope it’s of great use.
Factoring – General Considerations
Check the credentials of the factor. Check for trading history and backing. What is their net worth? Have they gone bust in the past and phoenixed? After all where would your business be if the factor ceased to trade?
What is the exact nature of your contract/agreement? One agreement I know of makes the client an “Agent” of the “factor” This also means that the invoices to the Client are not yours. If not done right, that can bring with it enormous complications regarding whose terms and conditions should be used and directors’ liabilities.
There are two basic charges with factoring: finance/discount or interest charge and an administration fee for the work involved in running your ledger. (N.B I have been supplied by a factor who constantly got the ledger wrong!)
Check the Administration fee – A percentage is just that, so check what it is charged on. Is it charged on the total value of sales or sales net of VAT? With VAT at 20%, 1% of Gross (inc VAT) is actually likely to be more than 1.1% of net. Make sure you do the sums before putting pen to paper.
How much money will actually be made available to you? Ask the factor to estimate this based on your usual spread of debtors, number of disputes, credit notes, debts past 90 days. Often it is very much less than the 80% or 90% quoted when “reserves” are actioned. Is it enough to finance your business?
What debt turn is the factor achieving? Check out the average debtor days or better still the days beyond the due date that the factor is achieving. It has been said that it is in the factor’s favour to have a longer debt turn as the client pays interest for longer. Old debts can also become more difficult to collect and if the factor fails to collect, do they take the debtor to court or simply re assign the debt to you and leave you to get on with the court case yourself? That’s OK if you know how to do those things but be aware of when that might happen.
Factoring – Possible Additional Charges
Check in advance whether any of the following charges will be made in addition to the standard finance charge and administration fee mentioned above.
Credit limit checks – how many are included in the service? How much do they cost each thereafter?
Old debts – if debts go beyond a certain age – usually 90 days past due date – will the factor make a ‘re-factoring’ charge to continue chasing the debts? I’ve known this charge to be as much as 1% plus of invoice value.
Spread Restriction – if an agency has a concentration of sales of 25% plus with one customer the factor may not finance any sales over that percentage. Find out the ‘spread restriction’ or concentration limit is. 25% could be a “killer” for a new start business with only a few clients.
CHAPS – how much will the factor charge for CHAPS payments? Work out how many you will need in a year.
Renewal Fees – may be charged on the anniversary of a factoring agreement.
Credit Insurance – if the administration fee includes protection against bad debt how much of the debt is covered? 75%? 100%? And when exactly will the factor pay out?
Credit Insurance – if debtors go bust with debts over 90 days old or disputed are you still covered?
Minimum Fee – some factors make a minimum charge per month or per annum regardless of the client’s turnover.
Service/Administration Fee – can the factor demand a minimum fee even if it has made no payment at all to the agency?
Arrangement or Commitment Fees – sometimes charged in advance – similar to bank overdraft/loan arrangement fees.
Termination Fees – if the agreed termination period is not adhered to you might have to pay the factor the equivalent of any lost income.
Notice period – sometimes, if notice is not issued within a certain period of the anniversary of the contract, you might automatically be locked into the deal for another year.
Value Dating – when a credit is made to your account with the factor, how long does it take for the account to be credited in your favour? Incoming payments may show on the account but when does the factor adjust interest charges accordingly. We have heard of one agency who checked (a time-consuming process) the interest charged by the factor and found a delay of 5 days on incoming payments. The agency was not surprised to find that when payment came out of its account that account was debited immediately – there was no matching delay.
So before putting your pen to paper because X% seems less than Y% - do check carefully. It’s not just a % figure you need to be aware of and then think that is it. It’s the total sum of all the potential costs and very importantly what service you get from the facility provider that matters.
If any IOR member would like a specific comment from me on a particular invoice finance matter, then please feel free to email me and I shall try to include a comment and answer in a future blog post, with anonymity for the member preserved of course.