How does Invoice Finance work?
It’s a frequently asked question, but how does invoice finance work?
In all three formats of Invoice Finance the Invoice Finance Company/Spot Factoring Company will make funding available to you normally based on 85% of the total amount of the debtors or the specific invoices involved in the case of Spot Factoring. So in a very simple example if you had a debtor ledger of £100k, you would normally have funding of £85k made available to you. However, the facility is flexible in so much as you decide how much of this funding you use and you will only pay interest on funds drawn down. You would access the funding by transferring funds from the Invoice Finance Facility to your bank account.
The 85% advance rate can be regarded as the industry norm but for good quality clients who have mainly high quality customers on their ledger a 90% advance rate can be achieved. Conversely if the provider has some areas of concern regarding you, your customers or your industry sector the advance rate can be reduced. Certain industry sectors do not necessarily fit particularly well with Invoice Finance. Construction is a prime example where complex contractual situations can lead to difficulties for Invoice Finance Companies. However, facilities can often still be agreed but the advance rate is likely to be no more than 50/60%.
Once the debtor pays up, the balance of the debt (less charges), is made available to you, i.e. the additional 15% in the case of an 85% advance rate facility.
Most Invoice Finance Companies can arrange bad debt protection for their clients against payment of an appropriate premium.
Cost of Invoice Finance
Primarily three elements of cost are incurred by the client:
- Set up fees. Typically 1% of the overall facility.
- Debit interest also known as Discounting Charge. This is normally in the range of 2 to 4% over Base Rate. In the current climate some of the independent providers terms are subject to a minimum Base Rate of 2%.
- Service Charge. This is difficult to define as the complexity of the ledger dictates the rate of charge applied. A client with just a few customers which they invoice monthly would expect to pay less than a client with hundreds of customers that they invoice weekly. A charge rate of 1% on the turnover passing through the facility is probably average.