Borrowings for working capital are used to provide short-term, flexible funding to meet your business’s day-to-day financing needs. Traditionally in the UK this requirement has been met through bank overdraft facilities, broadly secured by a charge over the company’s book debts or a personal guarantee from the directors. But as covered in Chapter 7, banks are increasingly reluctant to provide this type of facility, preferring to move borrowers on to debtor based factoring or invoice discounting arrangements and these lenders are in turn also increasingly adding an element of stock financing to their products.

There has always been a degree of stock finance available through trade finance houses, but this has been tailored mainly to funding imports and exports. Some of these lenders are now expanding their operations into more straightforward stock finance. Stand alone stock loans are also becoming available from the banks, but only at the £lm+ level due to the management costs involved. As will be apparent, many of these forms of finance are therefore becoming interrelated, as the different elements are all linked to the business’s working capital cycle. This chapter therefore covers:

Factoring And Invoice Discounting

Factoring and invoice discounting are both forms of finance that allow you to raise money directly against your outstanding debtors.

The easiest way to visualise this is to imagine that you can ‘sell’ your unpaid invoices to the lender at their full face value. This lender will then pay you for these in two instalments:

• an initial payment of the majority of the value (the advance, which is usually between 65% and 85%);
• with the remaining balance being paid, less the lender’s charges, once your customer has paid the invoice.

The impact of this is to short circuit the bulk of the normal debtor stage of the working capital clock and so accelerate your cash receipts up to the level of the advance percentage as illustrated in Figure 14.

Since the type of debt that can be discounted can include both goods supplied and services, this type of financing is often used very successfully by businesses such as temporary employment agencies, where the business will need to pay the employees out working on contracts on a weekly, fortnightly or monthly basis, but where its customers may not pay for these staff for up to two months from the date of invoicing. By factoring or discounting the invoices with a lender the business can obtain cash in on invoicing to match the work done and to pay the staff.

Of course the lender does not actually purchase your debt, but will take a first fixed charge over it as security for the advance. As a result, your debtors are then not available for your bank to use to secure an overdraft facility. Completion of a factoring or invoice discounting deal therefore usually involves paying off your overdraft out of the initial advance received.

While stock finance is discussed later in this chapter, it is worth noting at this stage that some invoice discounters will also take finished goods stock into account and can then offer higher levels of advance against invoices (sometimes exceeding 100% of your debtor book).

Factoring Or Invoice Discounting?