It is important that any business which uses invoice finance to fund growth obtains the highest possible prepayment against invoices that it can. However, sometimes the focus when selecting an invoice finance partner can be too much on the prepayment number – for instance “I have / am being offered 90% prepayment”.
All too often, the reality is different to the promise. It is therefore very important to establish at the outset what restrictions may be in place to limit overall funding. After all, invoice finance is not, prima facie, the cheapest type of funding solution – it is therefore essential that the facility is seen as value for money (or paying the least possible amount, for the highest availability of funds).
The “fly in the ointment” can be restrictions created by disapproved debt. These restrictions can be incurred for a variety of reasons. The more common ones are:-
- Customer credit limits – restrictions may be in place on the individual customer over and above any blanket limit applied. This can be mitigated by taking out credit protection to mitigate any funding risk to the finance company. Such protection could either be through the factor’s own policy, or through a third-party policy.
- Ageing of debt – any debts which surpass the funding period (known as “Recourse Period”) will be disapproved. The mitigation here is to ensure that, if longer payment terms are being offered to customers, the invoice finance company is able to offer a longer Recourse Period than the norm (ie usually 90 days). It is common for invoice finance companies to offer 120 days from invoice date, or even month-end of invoice date, should this be relevant.
- Customer disputes – as part of the process for both factoring and invoice discounting, invoice finance companies will verify debts as a matter of course (sometimes all debts, sometimes randomly and sometimes over a pre-agreed amount). Should feedback from the customer to whom the invoice is issued be negative, the invoice may be disapproved for funding purposes. The mitigation here is to work with the invoice finance company and the customer to ensure any issues are promptly resolved. Sometimes, such “disputes” are delaying tactics for payment, which is why it is important to ensure that a strong paper trail exists (ideally a written purchase order backed up by a proof of delivery).
- High Involvement / Customer Concentration limits – as a general “rule of thumb”, it canb be expected that, as a starting point, against an 80% prepayment level, any customer would be allowed to reach 20% of the overall ledger without restriction. For businesses with a large volume of customers, concentration will not be an issue. However, some business only have a few (or even one/two) customers – it is therefore important to ensure the funder is happy to fund such circumstances without restriction at the outset. Mitigating factors here would be a strong paper trail (backed by disclosure, if possible) and credit protection.
- Contra balances – if a customer is also a supplier to the business being funded, this can represent a problem for the funder. In a collect-out situation, this will impact on the recoverability of the debt. In some case (eg where the supply invoices are more than the sales invoices) it will be better to leave the debts out of the agreement (as “non-notifiable”). Should the supply be less than the sale, an agreement will need to be reached as to how any reserve for the contra balance is to be dealt with.
Negotiation regarding disapproved debts is always more difficult after the event – clearly it is important that any issues which may result in disapprovals are flagged up at the outset to fully understand the impact on overall funding.
As always, for any advice on this topic we are able to offer free and impartial advice.
