Five Reasons Why You Should Review Your Invoice Discounting Facility

1. Interest Rate

The headline interest rate makes up the largest proportion of the cost of an Invoice Discounting facility. However, it is crucial to determine whether the interest rate is properly aligned with risk.

Risk and interest rates have a simple relationship – the higher the risk of the facility, the higher the interest rate paid to compensate the financier. The opposite is also true – a healthy, profitable business which presents a relatively low lending risk should enjoy a lower or reduced interest rate.

Interest rates charged for Invoice Discounting facilities vary between approx. 1.5% and 5% per month. If your business has positive cash flows and operates profitably and consistently, you should expect an interest rate at the lower end of this range.

2. Ongoing Fees

Financiers charge a variety of fees for the provision of an Invoice Discounting facility. In most cases, these fees are justified on the basis that they reimburse the financier for costs. However, a properly priced and structured facility should fairly compensate for these costs as part of the interest rate – so in reality, additional fees represent surplus profit for the financier.

Financiers may charge any number of fees – establishment fees, legal fees, application fees, collateral fees and so on. These fees are not justified in most cases, so consider a financier which does not charge fees in addition to their headline interest rate.

3. Early repayment charges

Another type of fee which is often charged on Invoice Discounting facilities is an “early repayment” fee or penalty. The justification that is given is that this fee compensates the financier for the interest foregone as a result of an early repayment. This argument is also unjustifiable – once a facility is repaid, the financier has no further risk, and thus shouldn’t earn further interest on your loan.

4. Intrusive collection and audit processes

Many financiers will impose intrusive requirements as part of a facility, such as requiring invoice payments to be directed to a separate bank account which you do not control, conducting periodic audits of your business and debtors – for a fee in some cases – or contacting your debtors directly. These requirements are generally aimed at reducing the risk for the financier, however if an appropriate credit assessment is completed up front, these types of procedures are generally unnecessary. They can also harm your business if customers are notified that you are seeking short-term funding, since some customers could interpret this signal as an indicator that your company is experiencing financial difficulty, and avoid doing business with you altogether.

5. Low advance rate

The Advance payment or rate refers to the amount that a financier will lend against a specific invoice. Traditional financiers often limit the advance rate to 80% or 85% of an invoice. Again, this is a mechanism intended to reduce the financiers risk, but reduces the overall effectiveness of the facility for the customer.

Summing up

Invoice Discounting facilities vary widely in terms of interest rate, fees and other terms and conditions, which can often confuse a prospective borrower and confound their ability to make the right decision. Be sure to do your homework and select the facility that best meets your needs for the least overall cost. The switch could literally save you thousands.