Invoice finance, and the facility the target already has

What invoice finance is

Invoice finance advances money against invoices that have already been raised, so the wait for payment stops deciding what the business can do. The provider releases a proportion of each approved invoice when it is issued, and the balance, less its charges, when the customer pays.

There are two main forms and the difference is who deals with the customer.

Factoring. The provider runs the sales ledger and collects the money. Customers know the facility exists because they pay the provider. That suits a business that would rather not employ a credit control function, and it means somebody else is chasing.

Invoice discounting. The business keeps its own ledger and collects as normal, reporting to the provider. It can be confidential, so customers need not know. It is usually offered to businesses with proper credit control and reliable reporting, because the provider is relying on both of those.

Selective or single-invoice arrangements also exist, funding one invoice or one customer rather than the whole ledger. They cost more per invoice and commit less.

What makes an invoice fundable

A provider does not advance against the ledger total. It advances against the eligible ledger, and the gap between the two is where most of the disappointment lives.

• The work has to be done. An invoice for completed, deliverable work is fundable. An application for payment, a stage valuation or a bill raised in advance is a different animal, and many providers will not touch it.
• Ageing. Debt beyond an agreed age falls out of the facility, and in many agreements a customer's whole balance falls out once enough of it is overdue.
• Concentration. A single large customer is capped, so a ledger that looks healthy can fund poorly.
• Dilution. Credit notes, rebates and settlement discounts mean an invoice is not worth its face value, and a history of them lowers the advance rate for everything.
• Set-off and contras. Where a customer is also a supplier, the provider assumes the balances will be netted.
• Contract terms. Retentions, pay-when-paid clauses and rights of set-off in the customer's own conditions all reduce what the invoice is worth to a provider.

Worked exampleTake a ledger of 400,000. If a provider agrees an advance rate of eighty per cent, the arithmetic starts at 320,000. Then one customer accounts for 150,000 and is capped, 40,000 of the debt is past the eligible age, and 20,000 is owed by a business the target also buys from. What is actually available is a good deal less than the first number, and it moves every month as the ledger does. The figures here are invented to show how the calculation works, not taken from any deal.

How it is charged

There are two charges, not one, and comparing facilities on either alone gives the wrong answer.

The discount charge is interest on the money actually drawn, quoted as a margin over a reference rate. The service fee is calculated on turnover and pays for running the facility, whether or not much is drawn. On top of those sit an arrangement fee at the start, a minimum fee in many agreements, audit and disbursement charges, and sometimes a refactoring charge on debt that runs past its due date.

The last thing to check is the exit. Notice periods can be long and termination charges real, so the cost of leaving belongs in the comparison on the day the facility is taken, not on the day a better one is offered.

Where it fits in an acquisition

Invoice finance rarely funds the purchase price on its own. Its usual job is the gap that opens the moment the deal completes: staff and suppliers have to be paid on the old timetable while the customers pay on theirs. That is the same problem covered in working capital, and it is the most commonly under-funded part of an acquisition.

There is one deal item that catches buyers repeatedly. Where the target already has a facility, buying the business means that facility is repaid and replaced, or novated with the provider's consent. The day the ledger moves from one provider to another is a day with a cash shape of its own, because the old facility takes its money back before the new one advances. Model that day specifically.

Where there is stock and plant as well as a debtor book, a single facility across all of it may be better value than this one, which is asset-based lending. And the acquisition debt itself still sits where it always did, on senior term debt.

Who it suits, and who it does not

It suits business-to-business trading on credit terms with clean invoices for completed work: distribution, wholesale, recruitment, contract services and much of facilities management. It suits a growing business, because the facility grows with the ledger instead of being resized by application.

It suits an electrical and M&E contractor only with care, because applications for payment and retentions are exactly what providers discount hardest, and the right provider for that ledger is a specialist rather than a generalist.

It does not suit consumer or cash trade, businesses billing in advance, or professional practices that bill fees on account rather than raising invoices for delivered work. An accountancy practice has dependable income and very little of it looks like a fundable invoice, so the conversation there belongs elsewhere.

What goes wrong

The opening lump is treated as profit. The first drawdown against an existing ledger is a one-off release of cash already earned. Spent as though it were income, it leaves the business permanently short.

Availability falls when trade slows. The facility follows the ledger down, at the point the business most wants headroom.

A dispute freezes more than the disputed invoice. Many agreements make a customer's whole balance ineligible when one invoice is in dispute.

Reporting slips. On discounting, late or inaccurate reconciliations are the fastest route to losing the confidential arrangement or the facility itself.

Getting the ledger to a provider that will fund it properly

Providers differ sharply in what they will accept, and the difference shows up as the advance rate rather than as a refusal. A ledger full of applications and retentions is worth far more to a provider that funds contractors than to one that does not, and the second will simply price it low and let you assume that is what it is worth.

We know this market and we know specific people who fund ledgers in the sectors we cover, so the same debtor book goes in front of someone who reads it correctly. Tell us what the ledger looks like and we come back to you having spoken to them.