This article was first published in the April 2012 UK edition of Accounting and Business magazine.
Invoice finance providers have long evangelised about the suitability of debt-based lending for growth businesses and SMEs. Providing funding against invoices closely links the flow of funds to the working capital cycle, the argument goes. As orders increase, so can funding without any need to go back to the lender to rearrange the facility – as long as the new business is verifiable.
These lenders will have been delighted with research from commercial finance broker Hilton Baird suggesting a positive link between invoice finance and overall business health. Hilton Baird found that businesses using this kind of funding significantly outperformed those that depended on bank loans, overdrafts or loans from friends and family. They scored better in terms of profitability, turnover, growth and confidence.
The Hilton Baird biannual SME trends survey, covering 1,600 businesses, found that 31% of respondents overall were expecting their business to expand over the short term. Invoice finance users were the most optimistic group in the survey: 50% expected their business to expand over the next six months compared with 32% of bank overdraft users.
A consistent flow of capital always tends to increase confidence within a business. But is there a case for saying that invoice finance actually enhances performance? Bobby Lane, partner at London accountancy practice Shelley Stock Hunter, says the improvements seen by invoice-financed businesses are not necessarily coincidental. To his mind, invoice finance and asset-based lending are the best form of finance for growing businesses.
That flexibility argument is a strong one, Lane says, particularly with routes to traditional funding getting tougher. Look at recruitment agencies, he suggests: those deploying temporary workers will need to pay people weekly, while invoicing their clients on 45-day terms and incurring overheads along the way. ‘If that business starts to grow at a rate of knots, traditional facilities like overdrafts won’t cover its working capital needs. Invoice finance is easy to implement and access. It is able to deal with that kind of issue much better than bank finance,’ he says.
Invoice finance may also introduce some financial rigour. It can bring important, perhaps neglected, aspects of financial management into focus, Lane says. Companies often need to brush up their accounts and financial management procedures at the start of an arrangement. Providers will want to see management accounts, with some stipulating a deadline of two weeks after the period end. That might be onerous for a company that doesn’t produce them regularly but its introduction will generate useful management intelligence.
If an outside party is to lend money against invoices, then the debtor ledger needs to be up to date and credit control brought up to speed. ‘Whereas businesses might be plodding along without this information in place, when they have to provide it because a contract requires it, they do tend to look at things more closely. And that helps people control the business much better,’ Lane explains.
Other requirements of an invoice finance facility – such as trade insurance being in place to cover an unusually big order or a new and untested customer – will also encourage the owner-manager or director to think about the risk associated with their debt, he points out.
Andrew Dixon, executive director at Bibby Financial Services, says that the financial management and cashflow control that an invoice finance facility brings is a key benefit, for startups in particular. ‘For the typical business startup, the focus is very much on delivering orders and finding finance from whatever source they can, which is often a bank loan or a loan from family and friends to help get them started,’ he says. An invoice finance provider offers back-office support, as credit control can be taken off their hands.
‘One of the startups we have been working with in Scotland was struggling previously to fulfil orders and chase customers for invoices,’ Dixon explains. ‘Since taking on the facility, they are in a much better position to manage their cashflow and have gone from strength to strength, by being able to concentrate on maintaining a strong order book, which is continuing to grow rapidly.’
A startup’s lack of financial infrastructure can quickly bring it into danger, especially if its growth trajectory turns out to be a steep one. Tracey Bevis, business development manager at Pulse Financial, says she has seen new companies without the fundamentals – business plans or a consistent approach to invoicing.
One company that had grown its turnover to £5m was sending out invoices without a registered address, the company VAT registration or terms of trade. This kind of oversight may not matter in the early days, but it gives bigger customers scope to dispute payment further down the road. ‘Invoice finance may be a lifeline for cashflow reasons, but it can also be a safety net in terms of basic housekeeping,’ Bevis says.
The process by which invoice financiers verify the business’s debt can generate valuable insights into its operations. Bevis recalls a surge in credit notes within one company, a supplier of ceramic pots. An investigation discovered that a credit controller was regularly issuing credit notes against breakages. A new and less careful carrier turned out to be the cause of the problem.
The market intelligence an invoice financier can bring to bear on the debtor book can also prove invaluable when a business is changing hands, says Guy Walsh, business development manager for the Midlands at Venture Finance. A buyer will require a great deal of information about the business – more than the seller is in the habit of putting together. The due diligence a provider will typically carry out on the debtor book can help flag which customers provide the best margin.
Working capital insights
Walsh says: ‘People investing their own money in a business want to see a return and need some visibility on where that will come from. Unless you get to know the working capital cycle you won’t be able to see where you can improve performance or save money.’
Importantly, the visibility on customers can bring much-needed confidence – a feature largely absent from the current business scene. ‘It has to give you confidence if you know where you are and where you are going,’ says Walsh. ‘It’s all well and good taking on brand-new business or big orders, but if a customer delays when you’ve bought in supplies or takes longer to pay, you need to know the impact of that on your cashflow.’
Liz Loxton, journalist