Businesses waiting for customer payment can borrow against those invoices. The structure is useful and the pricing is opaque enough to be worth unpicking.
The two main forms
Invoice discounting advances a percentage of invoice value, with the business continuing to collect payment from customers, generally confidentially.
Factoring advances similarly and the finance provider takes over collection, which means customers know and deal with the provider.
Which matters commercially — factoring can signal financial difficulty to customers, though it has become common enough in some sectors that it does not.
The pricing components
Where comparison becomes hard, because there are several charges rather than one rate.
A discount charge, which is interest on the advanced amount, generally expressed as a margin over a reference rate.
A service fee, generally a percentage of turnover, covering administration and collection.
Arrangement and renewal fees.
And a range of additional charges — for credit checks, for disbursements, for handling disputed invoices, for terminating early.
Which means the headline rate describes one component, and the total cost as a percentage of the amount advanced can be substantially higher.
Recourse
The most consequential term.
With recourse, the business remains liable if the customer does not pay, and the provider recovers the advance.
Without recourse, the provider bears the credit risk, at a higher price and generally with conditions about which customers qualify.
Which means non-recourse arrangements combine finance with credit insurance, and the pricing reflects both.
Many arrangements described as non-recourse contain exclusions substantial enough to leave meaningful risk with the business.
Concentration limits
Providers limit how much of the facility any single customer may represent.
Which means a business with a concentrated customer base may find much of its invoice book ineligible, and the effective facility is far smaller than the headline.
Checking eligibility criteria against the actual debtor book before signing is the step that avoids this discovery later.
The lock-in
Contracts frequently run for a minimum term with notice periods, and termination fees.
Which makes switching costly, and providers price accordingly once a business is established on a facility.
Reviewing terms before renewal, and being willing to move, is the only real pressure available.
The alternatives
Worth considering before committing.
Negotiating shorter payment terms with customers, which is free and frequently possible with a conversation.
Early payment discounts, which cost a percentage and are simple.
An overdraft or revolving facility, which may be cheaper for a business with adequate security and a banking relationship.
Supply chain finance arranged by a large customer, where the customer's credit rating produces cheaper funding for its suppliers.
And, most fundamentally, invoicing promptly and chasing systematically, which addresses a substantial share of late payment without any finance at all.
When it makes sense
Businesses growing faster than their cash generation, where the alternative is turning down work.
Businesses with long payment terms imposed by large customers.
And seasonal businesses with predictable cash gaps.
It is expensive relative to conventional lending and available where conventional lending is not, which is the actual trade.
This describes how these facilities are structured and is not advice on any specific arrangement, which warrants a conversation with an accountant and, for larger facilities, a commercial finance broker or lawyer.
The application
Providers assess the debtor book more than the business itself, since the security is the invoices.
Which means a business with weak accounts and strong customers can obtain a facility where conventional lending would decline.
Due diligence generally includes verifying invoices with customers, which is how the arrangement becomes visible even under confidential facilities.
Disputes and dilution
Invoices that are disputed, credited or subject to set-off are ineligible, and providers monitor the rate at which this occurs.
A high dilution rate reduces the advance percentage and can trigger a facility review.
Which means operational quality — delivering correctly and invoicing accurately — directly affects the cost and availability of finance.
Exit
Leaving a facility requires repaying advances against outstanding invoices, which means finding the cash the facility was providing.
Which is why exits are generally arranged by refinancing to another provider rather than by simply stopping, and why the switching market is active.
Notice periods, termination fees and the mechanics of transferring the debtor book are all worth understanding before entering rather than when leaving.
Selective and spot facilities
Financing individual invoices rather than the whole book.
Which gives flexibility and generally costs more per invoice, and it suits businesses with occasional rather than continuous cash gaps.
Online platforms have made these considerably more accessible than they were, with faster decisions and less onerous contracts.
Accounting treatment
Whether the arrangement is on or off balance sheet depends on whether risk has genuinely transferred.
Which affects reported gearing and can affect covenant compliance on other borrowing.
Worth confirming with an accountant before signing rather than discovering at year end.