Factoring and Invoice Discounting: Be Wary of Hidden Fees
One practical method to fund the working capital of a business is the use of invoice factoring and invoice discounting.
Nowadays, this is already utilized as a source of finance for managing cash flow as well as a way of imposing discipline on the collection of outstanding sales invoices; before, invoicing was only utilized to assist businesses cope with financial hardships.
The process begins with the arrangement of a service charge fee – this is in general associated with the level of service provided as well as levels of underwriting risks for bad debts. On top of that, the client is made aware of any arrangement expenses and that interest on funds drawn is also applied.
Other considerations that may be taken into account when fixing the service charge fee include volume of invoices, value of invoices, percentage drawn down, maximum amount borrowed, the level of monitoring necessary and whether all or only part of the sales ledger is assigned.
The service charge fees for factoring are commonly at a higher rate of between 0.8 percent and 3 percent, than for invoice discounting since the factoring service charge consists of debt collection. Invoice discounting is usually cheaper because the company collects its own accounts.
Funders, then again, found a great source of profits by including a number of fees in the finance document. Hidden in the fine print, contingency fees are included that can be triggered by a default. A lot of lenders are trying to find reasons to trigger them as these premiums are adequately great.
Occasionally, the invoice discount provider pulls the plug on a facility and collects the outstanding debts to recover the loaned funds while they also retain the recovery and default fees.
While recovery fees are generally not specified, the default fee generally is set at 10% of the ledger held. Due to this, advisers to lenders are persuaded to recommend the exercising of rights under a default because they realize that they can be paid from the recovery fee.
On behalf of businesses, turnaround advisers often find themselves negotiating not to pull the plug when the real reason is to trigger default fees.
This self-interested behaviour is an excellent way to improve the number of lenders; yet on the other hand, this undoubtedly taints the finance community’s reputation.
This is why entrepreneurs who are interested in utilising invoice discounting as part of their cash flow option should look at all of the options, including “spot factoring” where there is NO contract or NO hidden fees. This is beneficial because fees are only applied when an actual transaction takes place and this can also be called upon on a per need basis. There is a form of factoring for almost all sectors, such as the special construction factoring.
Therefore choose carefully and think about all alternatives before committing to invoice discounting via factoring or an invoice discounting agreement!
