Recruitment and the hidden costs of invoice finance

Mon, 1 Feb 2010 | By Andrew Thomas, joint owner www.factoringquoteuk.com

An increasing number of recruitment firms are now financed through factoring and or its close relative invoice discounting. There are not many industries more suited to invoice finance than recruitment as having to pay contractors and temps often weeks before you get paid can place enormous strain on your cash flow.

Invoice finance is able to ease this strain by using your sales ledger to raise finance. The invoice finance provider will fund up to 95% of your total sales ledger as soon as you raise an invoice. This bridges the gap between paying temps and contractors keeping your cash flowing until your client makes payment. A number of invoice finance companies will also fund invoices for permanent placements, despite the risk of fee ’claw back’ if the candidate leaves within a certain time frame.

Of course nothing in this world is for free and for this service you will pay an interest fee on the amount loaned and a service fee for the administration costs. You have to decide whether the having this additional cash flow is more important to your business than the cost of the facility and to make this decision you need to be aware of all the costs, not just the standard costs.

The Standard Costs

People tend to only look at the two standard costs quoted when considering a invoice finance facility:

·      Service Fee - The cost of running your Sales Ledger and in the case of factoring, also your credit control function.

·      Interest - Charged against the amount of each invoice and usually expressed as a percentage over base rate.

Generally speaking the higher the company turnover the lower the percentage of these two costs.

The Terminology:

Factoring means the provider you choose will also run your credit control function. Invoice discounting will only supply the funds leaving you to run your own credit control. Collectively they are known as invoice finance.

Invoice Discounting v Factoring

Many companies prefer to manage their own credit control and so will opt for an invoice discounting facility. This is usually because they concerned that the finance company will not treat their client with due deference when chasing payment or they think that a company using invoice finance will be perceived as being in financial difficulty. A significant number of recruitment firms with temps or contractors will have invoice discounting or factoring facility in place so this view is becoming increasingly outdated.

If you do opt for a factoring facility then credit control is paramount, as the longer your client takes to pay the more expensive your factoring facility becomes. Many of the main clearing banks will offer great headline rates, but beware, as this could be a false economy. They may spend a lot less effort on credit control than some of the independent finance companies and if the debt is outstanding longer the interest accrued is greater.

As well as paying interest on debts that are outstanding for longer, you may have to contend with re-factoring charges if the debts go 90 days over its due date. When speaking to an invoice finance provider ask about re-factoring charges and examples of how they have reduced their clients “days sales outstanding” as this is a good measurement of effective credit control.

Concentration Limits

A concentration limit is an agreed figure of how much a provider will finance any single debtor as a percentage of the total sales ledger. Sometimes a provider will be unwilling to fund all of a particular debtor if that percentage is too large. This of course depends on the credit worthiness of your client base. If you are dealing largely with blue chip clients then it is less of an issue. However if you have a single debtor that makes up more than 20% of your sales ledger you need to ask about concentration limits. Also be aware that some providers will set the concentration limit, but should it be exceeded, instead of not financing the debt they will do so but will add a penalty charge. Ask about this as it is not something they advertise! 

Ensure you find out about all hidden charges

If you’re considering a facility, find out details of all the other charges such credit insurance for bad debts, charges for CHAPs (electronic inter-bank payments system) payments, penalties for funding higher client concentrations, minimum fees regardless of what you borrow, fees to renew your contract after 12 months, re-factoring charges, arrangement fees and other new and ingenious ways some invoice finance providers find of adding costs.

Finally, although generally contracts are for 12 months, if you’re not sure whether invoice finance is what your company needs or which provider to opt for then ask for a 3-month trial period. As always the proof is in the pudding and this trial period will give you an insight into what you could be letting yourself in for but with an opt out if things aren’t quite what you envisioned.