Digital Transformation » Systems & Software » Factoring – A new lifeline for the growing business

British businesses are finding it hard. Small to medium-size companies – even those with turnovers well in excess of #5m – are suffering from problems caused by poor cashflow.

One of the root causes of poor cashflow is the late payment of debt.

This has become a very topical subject since the DTI has been in lengthy discussions over it. Late payment is now seen as one of the most serious problems affecting UK SMEs today. But, despite numerous discussions in parliament – and the declaration from John Major that he will at least be advocating that government departments pay their bills on the allotted dates – little looks to be set in stone unless Tony Blair forms a new Labour government.

Yet, in a survey published recently, Alex Lawrie and the British Chambers of Commerce showed late payment to be threatening the survival of one in four firms employing up to 50 staff, and costing millions in reduced profitability in almost 75% of these businesses.

Indeed, the survey showed that 7 out of 10 companies are aware of at least one other firm being forced out of business by overdue payment.

Plus, 9 out of 10 believe their debtors deliberately pay late to gain financial advantage, with 6 out of 10 having to pursue debt recovery through the civil courts.

The Chambers of Commerce are in favour of legislation, and the CBI have conducted their own industry survey which shows that the survival of one in five firms is threatened by late payment. As a result of this they have introduced a prompt payment code – but this is not not the same as legislation.

One problem with imposing legislation for statutory interest on late payment is that the small firm could end up being squeezed on both sides.

In supplying goods to a larger company, the smaller firm may be forced to accept longer credit terms, or be faced with losing the order. And, if purchasing from a larger company, the smaller business may be forced into agreeing a short credit period. The business with the stronger bargaining power will win.

Despite the strong support for legislation, only one third of businesses would change their own policy on payments.

Another downside is that businesses may spend more time fighting claims and counterclaims for the interest due on late payment, instead of focusing on what should be their key business objective of driving their business forward. Therefore, legislation will become a distraction to many businesses, as well as an extra administration cost.

The Association of British Factors and Discounters (ABFD) conducted a study of payment among European factoring companies and found there was a correlation between countries with good payment records and those which give firms swift and effective access to the courts. The Woolf report recommendations, which are currently being implemented, will go a long way to improving access to the courts. It is this action which should be monitored to see how effective it is in the fight against late payment.

If we look back at the boom times of the 80s where UK businesses experienced rapid growth, we might see where some of today’s problems took a hold.

The impact of the recession exaggerated the problem of poor cashflow with most businesses experiencing its effects. Businesses reacted by cutting spending on key areas which in turn has impeded business performance in a post recession climate.

Financial directors relied almost entirely on traditional methods for solving day-to-day cash flow problems. As the decade progressed and recession took hold attitudes from the banking and other financial institutions forced businesses to adopt a new commercial acumen for the 90s.

What are the new commercial solutions for the 90s? How are businesses managing their cashflow and generating working capital to propel their business forward to the next millennium and enhance their competitiveness in a European or even world-wide market?

The traditional overdraft at the bank is no longer seen as flexible enough for many companies and of course, it isn’t tailored to individual business needs. Loans and venture capital are other options, but these may mean long term commitments and may not be suitable for many businesses.

An alternative option, growing in popularity in the UK, is sales-linked finance. With a growth level approaching 30% last year, this modern option has accounted for #30.4bn of extra liquidity in the UK market last year.

The appeal of this option is both its simplicity and its flexibility, as it releases up to 85% of businesses’ unpaid invoices, providing the vital working capital today’s businesses need. Plus, this working capital is directly linked to the performance of the business, so the more the business sells, the more working capital is available for effective investment in developing your business.

An additional aspect of this facility is the provision of sales ledger management, which frees important management time and resources to concentrate on the key objectives of developing the business.

A misconception is that the factoring and invoice discounting industry will suffer if legislation is introduced because their products are a solution to late payment. The reality is that this industry will benefit from proposed legislation, because businesses will want to outsource the management of their sales ledger, and with it the problem and additional time required to collect interest due on late payment. This situation is evident in Sweden, for example.

At first glance, it seems a sensible and realistic option. However, the factoring and invoice discounting industry is hindered by the existence of two myths: firstly, that it is a “last resort” finance option for businesses who are looking to prolong the demise of their business by a short period of time and secondly, that it is an expensive option. These myths are borne out of and exist with the help of ignorance. Not enough information is available on how these services can benefit businesses.

In answer to the two myths, sales-linked finance succeeds in freeing up a supply of working capital to help a business develop and grow. It is, however, not an answer to bad business management. If the released funds are not coupled with best practice, then, unfortunately, the business cannot prosper.

Secondly, sales-linked finance is no more expensive than the other alternatives in the market. There are essentially two fees: first, the cost of the money used, which is up to 3% above bank base rate. This is more than competitive with an overdraft.

The second fee is for service, and this on average is 1.2% of annual turnover for those who take up the option of sales ledger management.

So on a turnover of #1m the service fee would be on average #12,000, and could be less. Compare this with the running cost of a small accounts department and sales-linked finance can begin to make a lot of sense.

For those businesses who take up invoice discounting, the fee will be substantially lower, because the businesses manage their own sales ledger.

Is there another catch? Is it the “fear factor” which worries people most, and the British distaste for outsiders handling one of the most private aspects of their business?

Nik Nicholas of upmarket bridalwear specialist Helen Marina, which has taken advantage of sales-linked finance since 1991, says: “The service has given us the confidence to grow quickly, safely and efficiently.” In a relatively short period of time, the company has been able to expand into the export market and develop their profile within the UK, where they have been nominated for Bridal Designer of the Year for the third year running.

Timeplan Education Group is another example of how sales-linked finance has helped a business prosper from #200,000 to #11m in just five years.

According to Tish Seabourne, managing director of Timeplan: “For a recruitment company, our growth rate was huge, but so was the gap between invoicing and payment. I can’t imagine any other source of finance that would have kept pace with our growth.”

A wide range of service industries have enjoyed hassle-free infancies – even in the 90s – with the help of sales-linked finance, leaving them free to take on the “big boys” as the economy slowly begins to grow again.

An excellent example here could be taken from the growing numbers of MBOs, which have prospered in a relatively short time from using sales-linked finance, which has freed monies for the more important aspects of funding the buyout.

The recessionary years of the early 90s have been punishing times for many fledgling MBOs, but Leeds-based computer consumables specialists Accurate UK have found that sales-linked finance has helped them through the initial vital years.

“In our first year, we achieved a turnover of around #1.5m, increasing dramatically to #2.5m in the second year,” says managing director Jeff Eke. “As directors of a new business, we all recognised that healthy cashflow would be vital to the success of the company, and sales-linked finance helped us with a professional and effective sales ledger facility – which meant the costs saved in staff and administration were invested in expanding the business.”

Factoring has been around for about 30 years, but is becoming increasingly applicable to the modern business of the 90s and top names in business and finance have suggested that sales-linked finance can play a vital role in the development of British companies.

Sir John Harvey-Jones has been quoted as saying that more small businesses are turning to sales-linked finance, especially as banks are increasingly not able to provide working capital, but actually in many cases squeeze small businesses for the loans they have already made. Eddie George, governor of the Bank of England, has said that factoring and invoice discounting could usefully provide businesses with the opportunity to grow.

Howard Davies, director general of the CBI, has also said that small companies could help themselves by making more use of factoring and invoice discounting. He has also made the point that initial payment obstacles faced by small firms moving into export markets could also be cut by the use of cross-border factoring.

This brings us to the significant growth there has been on the international market, where the industry has trebled in size in recent years. A re-design of the “global” office has come with this growth, as less emphasis has been placed on administration and accounts, and more on the advancement and best use of technology, coupled with aggressive sales and marketing strategies, making companies more ideally honed for growth. Could this be the shape of the UK office to come?

Moving into the next millennium, UK companies can expect to experience increased competition from companies worldwide. With language, cultural and currency barriers restricting the growth of UK companies on the worldwide stage, many may find that sales-linked finance is the solution. With dedicated multi-lingual resources assisting many UK companies, and the existence of reciprocal arrangements with factoring houses based all over the world, UK businesses can export with improved confidence.

With the need to increase investment in terms of advancing technology, new product development and sales and marketing, many companies may well find that sales-linked finance will leave them with more time and money to invest in these areas. It’s certainly one answer in an ever more competitive market and slow growing economy.

Janet Green is financial director at Alex Lawrie.

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