Insights

Running out of cash is one the most common reasons why a perfectly good business ends up in administration. As a result of the recession, many a sound business operation has encountered cash flow problems and for some, it is the nail in the coffin. Frequently, these businesses have no other inherent issues and can represent excellent value for money for business turnaround and rescue venture capitalists looking for a bargain investment that will quickly generate profits. Paying close attention to cashflow is therefore essential to ensuring your business doesn’t become one of the insolvency statistics and gets snapped up by venture firms.Last month, we looked at how to improve working capital management and why this is essential to being successful. This month, we’re looking at one method to help ease strains business owners might have with cash management, using invoice discounting.

Invoice discounting is a form of asset based lending, using sales invoices as collateral. The company effectively sells the sales invoices to a third party finance provider, who in return, pays the business owner part of the total sales amount due in advance of being paid by the customer. When the invoice is paid, the finance provider pays the balance to the seller, minus interest and administration costs.

Invoice discounting has always suffered with something of an image problem and many businesses are wary about adopting the practice. One reason why business owners can be reluctant is because of a perception that a business using invoice discounting must be struggling financially but the service is discreet and customers need not be aware a business is using such a facility

Our first hand experience suggests many business owners have benefitted greatly from financing their business in this way and significantly improved cash flow levels. It is especially useful in situations where a business has to accommodate customers who are able to demand longer payment timescales than its suppliers. For instance, some larger companies - usually major brand owners - are forcing their suppliers to accept payment timeframes of 90 days, yet the business owner may have to pay its suppliers and subcontractors after 30 days.

In addition to smoothing cash flow fluctuations, invoice discounting can also improve customer relationships by taking away the need for a company to chase its customers aggressively for payment but it is still important you have an effective and efficient credit control system in place.  The additional cash obtained from the provider can then be used to potentially negotiate better rates from suppliers for early payment or purchase new stock items.

As with everything there are pros and cons that should be weighed up before making a commitment to an invoice discount facility. One of the biggest disadvantages is potentially having to make a long term commitment over a number of years, when the financial requirement for invoice discounting is much shorter.  Companies should therefore be aware of the small print before entering into an agreement and negotiating the most appropriate timeframe possible. Invoice discounting is also not the only source of short-term finance for a business and should be considered alongside other options.

If you would like to discuss raising funds for your business or concerns about how to manage cash flow, please contact Simon Paterson by emailing sp@rjp.co.uk.