To the manufacturer scrabbling for money to finance growth, the options might seem limited: bank loans or stock market funds. But there is an alternative — factoring and invoice discounting. Companies offering these services will lend money against invoices, anything up to 90% of outstanding payments.
According to the Factors and Discounters Association (FDA), at any given time, factoring accounts for £4.7bn of additional liquidity in the UK economy. About £60bn worth of invoices is currently handled for FDA clients.
How does it work? For many firms, the money they are owed is their largest asset. The factoring company can provide not only collection of these debts, but also credit management services. The factor will then fund the bulk of outstanding invoices. The charge for the service is a percentage of turnover, usually between 0.75% and 2.5%. Finance is provided at rates close to those quoted for bank overdrafts.
Engineering firms are particularly attractive to the factoring industry. This is because they produce a defined product in a defined timescale. Paul Saunders, commercial director at factoring firm Alex Lawrie, explains: ‘There are some industries we are not too happy to deal with, for example construction, where work tends to be undertaken on extended contracts. We prefer a tangible end product.’
Factoring is usually recommended for companies with turnover over £100,000, though it is on offer for smaller firms. When companies grow beyond £1m turnover, they often have their own credit management schemes. But they may still need to turn outstanding invoices into cash. Rather than using factoring, they tend to employ invoice discounting. This can provide cash for up to 85% of debts, but unlike factoring, the company itself organises accounting and administration. The use of invoice discounting is not disclosed to the business that owes the money.
The factoring industry also claims it can help small and medium businesses with other forms of asset-based finance. Usually, this will be secured against stock values and plant and machinery.
Despite the range of services on offer, factoring has suffered from an image problem. Until recently, it was seen as ‘the last chance saloon for a shaky business’, according to David Robertson, chief executive of Bibby Group of Factors. But this has changed.Recent surveys show accountants increasingly recommend factoring to companies going through rapid growth, or looking for credit control.
Saunders says he currently deals with 4,000 companies with an average turnover of £0.5m. In the last 12 months alone, he has acquired 580 new customers. ‘Growth is very strong because we have become more aware of the needs of small businesses,’ he says. ‘They have a cash need that cannot be satisfied by banks.’Alex Lawrie is in fact owned by a bank, Lloyds TSB Commercial Finance. The big clearing banks dominate the market. But competition from a growing number of independents is fierce. Alex Lawrie will now fund 90% of companies’ debts, up from the traditional 80%. ‘Our services are not just suitable for times of recession. We are saying small businesses should see us as a viable alternative source of finance — not as a last resort,’ Sanders says.
There is a perception that factoring is more expensive than bank finance,particularly for smaller businesses. ‘Compared to the cost of an overdraft it can in fact be cheaper,’ Sanders argues. ‘Our funding costs a maximum of 3% over base rate.’ He concedes that there are extra fees for administration, but argues: ‘We are providing a professional sales management service.’
For manufacturers who export and import, factoring cannot have a direct impact on the effects of a strong pound. But there is scope to finance overseas assets and to deal in local currencies. The size of a company does not matter, nor how much they export. ‘We are very much misunderstood,’ Sanders argues. ‘Although funding for exporting is not a principal part of our business, certainly any engineering company worried about exporting will get support from us.’
Steven Anderson, sales director at Bibby, says: ‘We have credit controlspecialists fluent in several languages. We also maintain bank accounts abroad. Funds can be credited the next day, rather than UK clients having to wait for money to go through the system.’
Invoice discounting, with a target market of companies with a turnover of over £0.5m, is also a growth area. For the last six years it has been expanding at a rate of 20% per annum compound, says Ian Lomas, commercial director of Lloyds TSB Commercial Finance. He reckons that the manufacturing sector accounts for about 35–40% of clients. In the Midlands, the percentage is higher.
Business is often referred by the parent bank. In the majority of cases, invoice discounting will replace a bank overdraft, and often it will be in place for four to five years, ‘It is amazing how often companies will use us in times of fairly rapid growth, for things like purchasing machinery. They will make a profit, generate cash then come back in the next cycle,’ Lomas says. Discounting is often used in situations such as management buyouts to lever assets. It reduces the need for outside equity from sources like venture capitalists.
There is a ceiling, though, to how many companies can make use offactoring and invoice discounting. Anderson warns that factoring is not right for a stagnating business. Many businesses work smoothly on an overdraft, especially those that are well established. However, he reckons in addition to the 70,000 firms usingfactoring companies there are a further 350,000 in the UK who could benefit.Factoring should no longer be seen as a ‘poor relation’ to bank finance, says Anderson: ‘In the 1989/91 recession it came into its own, and proved itself to be a secure form of lending.’