Invoice Finance Guide
Invoice Discounting
Invoice Finance - Invoice Discounting
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Invoice finance has emerged as an increasingly more important form of commercial finance and invoice discounting, the most popular form of invoice finance for larger companies, is now growing at almost double the rate of factoring.
To understand the reasons behind the growth of invoice discounting and the advantages it can offer, the nature of this service must be looked at from both the perspective of the discounter and the borrower.
The Business Benefits of Invoice Discounting
Many businesses predominantly borrow from their clearing bank and do so on a cash flow basis i.e. the bank is making a judgment on the security of a loan by taking a historical view of a business’ cash flows and lending a sum of cash relative to this. Unfortunately, for most businesses, this limits the levels (or leverage) of money which can be borrowed:
- Only businesses with a long trading history will be considered
- Only businesses with an unblemished trading history will be considered
- Many businesses do not have a high net worth thus do not have assets which can secure loans
- Many assets cannot be borrowed against due to low resell values
It is for these very reasons that invoice finance and invoice discounting have become preferentially to traditional commercial borrowing. At the heart of an invoice finance facility is the fact that invoices are legally recognised rights to payment and therefore a valuable asset. Invoices can also be assigned from one business to another, allowing invoice financiers to lend money to a business secured by the legal right to an invoice.
The basic invoice discounting process works as follows:
- Stage 1 Discounter notified at point invoice can be written.
- Stage 2 Discounter advances agreed rate of invoice value. (potentially 24 hours later)
- Stage 3 The invoice is paid.
- Stage 4 The invoice balance is paid by the discounter. (minus their fees)
Some advantages to the business borrower now become clear:
- The amount which can be borrowed is dependent upon the volume of invoices which are raised i.e. your cash flows can keep up with your expenses as you grow
- As invoices are used as the main security in this transaction and invoices are one of the best forms of asset in an insolvency, in most cases directors’ personal assets are not as risk
- While an overdraft is inflexible and can be withdrawn by the bank, invoice discounting is flexible and cannot be withdrawn
As the popularity of invoice discounting has grown it has acted as a further driver in lending innovation leading to the current developments in asset based lending which has allowed even more flexible commercial borrowing.
Asset Based Lending
Asset based lending has developed as an extension of invoice discounting by allowing businesses to add an increasingly diverse number of assets to the invoices being discounted allowing a “wholistic” lend. Most asset based lenders insist on a minimum of 40% of all cash borrowed to be secured with invoices while the remainder can be secured from:
- Plant and machinery
- Wheeled assets
- Commercial property
- Stock/inventory
As a result the leverage created is far larger than has been previously achievable via traditional secured lending.
Bank benefits of Invoice Discounting
When considering a the banks’ preference for invoice discounting as a means of lending money to the commercial sector two aspects must be considered: legal and regulatory.
In recent years various court cases have challenged the notion that banks that have held floating charges over a company’s assets also retain a right to the accounts receivable. While decisions have fallen on either side of the argument it is generally thought that, in the future, a definitive case will be brought which will remove this claim. As has been discussed, invoices are often the largest asset on a company’s book and thus the banks may not be able to extract their money as a preferential creditor.
An obvious answer to this problem is for the bank to offer an invoice secured facility.
Recent regulatory requirements such as the Basel II capital adequacy accord have also placed increased pressure on the banks. Under Basel II the banks are obliged to keep better track over their spot liabilities ensuring that capital reserves are, at all times, adequate to cover liabilities. By introducing the bank’s invoice discounting unit to the client the asset based lend can be continued while ensuring compliance at a lower cost.
Terms for Invoice Finance
Invoice finance goes by many different names although there are only two services which are widely used by businesses throughout the United Kingdom. Invoice discounting and factoring are the two main forms of invoice finance, they are also known as invoice factoring, debt factoring and invoice factoring.
