Invoice finance is a staple service often required when recruitment agencies are making contract and temporary placements. With that said, recruitment agencies who have never had one of these arrangements can find it somewhat daunting when signing up and often become confused with the terminology used. As many of these arrangements involved signing legal documents, registering debentures at Companies House and guaranteeing funds borrowed, it is important for agencies to understand what they are agreeing to.
Below, TBOS list the most frequently asked questions by clients in relation to invoice finance:
DIFFERENCES BETWEEN INVOICE DISCOUNTING AND FACTORING
Invoice Factoring is a funding facility where the invoice finance company will lend funds against each invoice raised. These funds are funded from the date of the invoice raised for an agreed period of time or until the invoice is paid. Each invoice is assigned and notified to the invoice finance company separately with the invoice finance company chasing the debts on behalf of the agency.
Invoice discounting is a funding arrangement where the invoice finance company will lend funds against the total outstanding debtor book. The agency will fund against the total amount of the invoices raised and reconcile any funds received by the invoice finance company to ensure the debtor book is up to date. Often the invoice discount arrangement is confidential so the agency’s clients will be unbeknown to the funding arrangement. Within invoice discounting the agency will chase their clients for payment of the invoices.
WHY AND HOW THEY CALCULATE INVOICE FINANCE SERVICE CHARGES
The Service Charge is the fee charged by the invoice finance company to allow the agency to borrow the funds against the invoices. Often this is charged as a percentage of the full invoice value (including the VAT) or as a set monthly fee. Sometimes the Service Charge may also include bad debt protection or credit insurance if this has been agreed when the facility was initially set up. Invoice finance companies will use the projected annual turnover of the agency, the industry they will be recruiting for, potential client base and their back office and accounting processes in place, to assess the risk of funding. The invoice finance company will then use this to calculate the service charge percentage that will be used for the duration of the funding arrangement.
MEANING AND CALCULATION OF THE INTEREST
The Interest or Discount Rate is charged on a daily basis by the invoice finance company on the balance borrowed by the agency. Often the interest rate will be based on the discount rate plus a bank base rate, either by the Bank of England Base rate or LIBOR (London Interbank Offered Rate). The daily interest charged is calculated by multiplying the amount borrowed by the interest rate and then divided by 365 days. The discount rate used for the duration of the facility is based on the projected annual turnover of the agency, the average client payment terms, the credit control processes to assess the amount, the level of funds required and the charges imposed.
MEANING OF DRAWDOWNS
Drawdowns are the request by the agency to borrow funds from the invoice finance company. Often these requests are logged on the invoice finance company online system and will be sent to the agency bank account for them to use the funds to pay contractors and suppliers. The funds drawndown will include funding against current outstanding invoices and an element of remaining funds against invoices which have been paid to the invoice finance company.
MEANING OF AVAILABILITY
Availability is the amount of funds that the invoice finance company will allow the agency to drawdown to their business bank account. The availability is calculated as a percentage (often 75-90 per cent) of the current debtor book minus any ineligible debts and any funds previously borrowed. As invoices are raised the availability will increase by the prepayment percentage (often 75-90 per cent) and as invoices are paid the availability will increase by the remaining prepayment percentage (i.e. 10 per cent if the agency is on a 90 per cent prepayment). The invoice finance fees are the only other factor that may affect the availability.
WHEN AGENCIES SEE THEIR PROFIT
Invoice finance arrangements are like a revolving bank account so it is often hard to pinpoint with a facility when the agency will see their profits. If an agency has an average margin of 20 per cent but a 90 per cent prepayment then as invoices are raised the agency can choose to drawdown some of their profit in advance. Once the client makes payment the remaining profit is then available (minus the invoice finance charges). As invoices are raised and payments are made it can become difficult to pinpoint actual profits but they are there.
MEANING OF INVOICE FINANCE RECONCILIATION
Invoice finance reconciliations are completed by agencies who have an invoice discounting facility. These reconciliations are done to ensure that the balance shown on the agencies debtor book matches the figures shown on the invoice finance companies system. As long as the agency notifies the invoice finance company of each invoice, credit note and marks off every payment received – both balances should always match. Some invoice finance companies now have software that speaks to the agencies accounting software to do these reconciliations automatically.
HOW LONG WILL THE AGENCY RECEIVE FUNDING FOR
The length of funding provided by the invoice finance company to the agency will depend on the risk assessed on the client base, industry, credit control processes and the appetite of the invoice finance company themselves. Often this can range from 60-120 days from date of invoice or end of month date. This means that the invoice finance company will provide funding for that period or until the invoice is paid by the client. If the invoice exceeds this funding period then the invoice finance company can recoup the funds lent against the availability allowable.
WHAT ARE CONCENTRATION LIMITS
Concentration limits are imposed by the invoice finance company to avoid the agency putting all or most of their business with one particular client. Often the invoice finance company will want the agency to have a good spread of clients to avoid a risk to the debt should anything happen to that client. These concentration limits can also be imposed on the percentage of overseas debtors or percentage of credit worthy debtors. If the agency exceeds these concentration limits then then they will have their availability restricted until they fall below the agreed limits.
WHAT ARE FUNDING LIMITS
Funding limits are often imposed by the invoice finance company as a guide to the amount they initially lend to the agency. This is based on the projected annual turnover and the average payment terms from the clients. If the agency hits the funding limit imposed then the invoice finance company will assess if this is based on whether the agency has achieved their projections or if their clients have missed their payment deadlines. The funding limit will be increased to support the agency as long as the business has grown and the procedures agreed are being followed.