How Do Invoice Finance Companies Calculate Their Service Charges?
Invoice finance is key to any recruitment business making contract/ temporary placements as more often than not, the candidates will need to be paid before the client makes payment of the agency invoices. Invoice finance companies work by making funds available at an agreed percentage (75-90%) against invoices raised for the agency to draw down to their bank account to pay the candidate. The client will then make payment to the invoice finance company, allowing them to release the remaining funds. The invoice finance company will then levy a service charge based on the invoice values uploaded and an interest/discount rate on the funds that are borrowed.
The way that Invoice Finance companies calculate the rates they should be charging is often seen as a complex formula which is generated based on credit risk and industry factors. However, over the years TBOS has realised that there is some logic behind how these rates are calculated, and we would like to share some of our findings on the factors that can affect proposed rates :-
- Factoring vs. Invoice Discounting
Invoice Finance companies will offer recruitment agencies either Factoring or Invoice Discounting depending on their company age, turnover size and back office capabilities. Agencies using a factoring facility will often pay a higher service charge than a company using an invoice discounting facility, as the invoice finance company will have to manage the credit control and funds reconciliation process. However, if the agency has an invoice discounting facility, the credit control and debtor management is handled by the agency and thus the fees charged by the invoice finance company should be lower.
- Projected Turnover
The main service fee indicator is the company’s projected turnover for the next 12 months. Often, the higher the turnover presented, the lower the service charge the invoice finance company can provide. However, it is important to get the projections as accurate as possible because the invoice finance company will often charge a minimum fee (monthly or quarterly) which is based on 75-80% of the projected turnover. For example, if the service charge on £1m projected turnover is 1% and you only raise £150k by the year end, you could still end up paying £7,500-£8,000 of minimum fees.
- Industry and Potential Client Lists
The industry that you are making placements into can have a significant effect on the service charge being offered. If you are making placements into the public sector (medical, teaching, government) where the risk of non-payment is lower in comparison to the construction, engineering and logistics industries, this will have an effect on the rate that the finance company proposes. Invoice finance companies will also want to know which clients you are potentially going to be dealing with so they can assess the credit worthiness in advance and decide if there is a risk of non-payment. Invoice finance companies will also be on the lookout for clients invoicing through RPO’s and intermediaries as this can create a barrier to payment of the invoices.
- Debtor Concentration
Often, invoice finance companies will restrict funding to an agency if there is a significant concentration of debt with one company. If it is evident from the beginning that you are making the majority of placements with one main client, the invoice finance company may impose a larger fee to compensate themselves for the risk of “putting all your eggs in one basket”.
- International Placements
Many invoice finance companies can provide funding on international or currency placements, but this again is seen as a higher credit risk compared to UK placements - the work involved in credit controlling and chasing international debts can have an impact on the service charge being offered.
- Credit Insurance/Bad Debt Protection
Credit insurance or Bad Debt Protection can have a positive effect on the service charges being offered by invoice finance companies because if the debts are insured, this reduces the risk of the invoice finance company not being paid. However, the cost of the credit insurance is often higher than the saving made on the service charges so it is important to decide by reviewing your clients and their individual risk before agreeing to take out the additional credit insurance/bad debt protection.
- Payment Terms and Contractual Clauses
Generally, an invoice finance company will want to know what kind of payment terms the invoices will be paid in line with in order to assess how long they will be funding individual debts for. Also, if the payment terms are between 60-90 days this may mean they are funding 2-3 months’ worth of contractor invoices before they receive their first payment. Other contractual clauses such as pay-when-paid, ban on assignment and payment by application can also have a detrimental effect on whether the invoice finance company can provide the funds, leading to an increase in the service charge to reduce their risk.
TBOS works with many invoice finance providers to ensure that the invoice finance arrangements that are set up meet the demands of the recruitment agency’s future needs, whilst being based on realistic sales projections. TBOS ensures that their agencies are fully aware of the commitment they are making and any restrictions to their funding that they need to know about. As TBOS provides the full back office and accounts processes to the recruitment agencies, the pricing provided is often lower and at preferential rates due to the reduced risk to the invoice finance company.
For more information on how TBOS can help with setting up your invoice finance arrangement or reviewing your existing invoice finance arrangement to ensure it is priced correctly, please contact our office.