In this article, TradeBridge Sales Director Grant Fraser calls on over 10 years’ experience working in supply chain finance (SCF) to explore four scenarios where invoice discounting (ID) can only provide a partial solution to working capital challenges.
Using real life examples, Grant looks in depth at each scenario and shares his thoughts on how supply chain finance can bridge the working capital gap that invoice discounting often leaves.
Scenario 1: Overseas clients
Dalau manufactures high quality component materials for a range of industries worldwide.
Four years ago, Dalau were trying to refocus their business, and at the same time were experiencing liquidity challenges, mostly caused by their invoice discounting facility. Because of their international client base, their bank perceived a higher-than-normal level of risk, and instead of allowing Dalau to draw down the promised 80-90% of the value of outstanding client invoices, they were restricted to drawing down just 60% of monthly sales value.
For a business that is billing £1m in monthly sales, the shortfall between projected and actual draw-down was £200-£250k.
Dalau approached Woodsford TradeBridge and we were able to put in place a supply chain finance facility to bridge the liquidity gap. Having a separate working capital facility to pay suppliers reduced the pressure on the invoice discounting facility and enabled management to focus on running their business.
Fast forward 4 years, and Dalau’s working capital toolkit looks somewhat different.
They were able to move their ID facility from their bank to a provider who better understood their business model, improving the draw-down percentage and reducing the liquidity gap even as sales revenue grew and they invested in new capacity.
They have chosen to retain and continue to use their supply chain finance facility from Woodsford TradeBridge because it bridges any liquidity gaps, enables negotiation of better supplier terms and gives the business full confidence that their working capital toolkit is fit for their business.
Compare the costs: Invoice discounting vs. supply chain finance
1. The cost of invoice discounting (ID)
So, what does invoice discounting cost the business? Invoice discounting facilities are offered at head-turning rates, typically just 2.5% above base rate. BUT that’s not the whole picture. Businesses need to account for the following additional costs:
• Arrangement fee
• Annual service fee
• Minimum monthly fee (regardless of whether the facility is used)
• Transfer fees
This can lead to an ID line costing the business between 6 and 12% over the year.
2. The cost of supply chain finance (SCF)
What is the real cost of SCF? Different providers will charge different rates, and these are likely to change over time. At time of writing, however, Woodsford TradeBridge typically charges clients 1% per 30 days. However, this is ALL clients pay. There is:
• No arrangement fee.
• No annual service fee.
• No minimum monthly fee (if you don’t use the facility, you don’t pay for it, which is great for businesses whose monthly cash position fluctuates).
• No transfer fees.
For complete peace of mind, a facility that is there when you need it, but that you do not pay for unless you use it, can complement an invoice discounting facility, at a relatively low cost to the business.
Scenario 2: Concentration risk
Relying on a small number of very large customers can cause issues for ID.
This “concentration risk” is seen by banks as problematic, as the loss of a single customer can dramatically impact the business’s debtor book.
I recently spoke with a profitable business that had always traded with the same four customers, with consistent turnover year-on-year. The business suffered two unfortunate events at around the same time. One of their customers went into administration and another required them to rebid for their business – unfortunately they lost the pitch.
With the business down to two customers, their debtor book was reduced, limiting the available funding through their ID facility. At the same time, the bank deemed that their concentration risk had increased, reducing the draw-down % on their ID facility from 85% to 60%.
The reality is that the business overheads could not be reduced overnight – yet their working capital had been effectively halved. At that point, the risks in the business were high, which made it very difficult for them to seek the additional funding needed.
If the CFO had agreed a supply chain finance facility when they were thriving, this would have given the business a solid working capital backup. Because Woodsford TradeBridge customers only pay for their facility when it is used, the additional cost of adding SCF to their working capital toolkit would have been minimal.
Sadly, in this instance, the business had put all their eggs in one basket, and also left it too late to arrange an SCF facility, putting them in a challenging situation.
I would always recommend putting a supply chain finance facility in place when the business is thriving. As well as giving working capital flexibility and predictability, it offers the business much needed breathing space (and time) to secure new revenue streams in the event that they lose one or more customers unexpectedly.
Scenario 3: A large number of small customers
Invoice discounting can be problematic for any business that works with a large number of smaller customers, especially when many of these customers place ad hoc orders or are based in international locations.
In reality, there is a sweet spot for invoice discounting, of between 20 and 200 customers. Businesses that have more than 200 customers, or less than 20, will typically find that invoice discounting does not provide sufficient working capital for predictability in their cash position.
– Grant Fraser, Sales Director, TradeBridge
Uncertainty and change are inevitable for businesses like this, meaning that the business’s ability to effectively predict working capital position – and therefore their capacity to plan ahead – is compromised.
Whilst the business may have an invoice discounting facility in place, it is likely this will only apply to a fixed number of customers, rather than to the whole debtor book, and therefore the business’s ability to draw down against the value of the debtor book is diminished.
A TradeBridge SCF facility is determined based on the strength of the balance sheet and is therefore calculated in a different way from ID. Adding supply chain finance to the working capital toolkit therefore gives the business additional working capital flexibility.
Typically, the SCF facility is also unsecured, so can sit gently alongside invoice discounting without requiring additional security.
Scenario 4: The construction industry
The construction industry is unique in that subcontractors tend not to raise invoices – which causes problems for invoice discounting.
Instead of raising invoices, subcontractors make an application for payment. This is less tangible than an invoice and is also open to reduction.
For example, a bricklayer may request payment for building a wall 20 feet high. After a week, he submits an application for a 50% payment, but the site manager spots a problem with the finishing, so he is paid only 40%.
Some financing houses will provide invoice discounting facilities for the construction industry. However, because of the uncertainties in the process, the interest rates and charges payable tend to be higher than for other industries.
Typically, they will also only offer 50% draw-down. For a business that is processing applications for payment of £1m monthly, for example, this will lead to a £500k liquidity gap.
For construction, therefore, the need for supply chain finance, which is calculated based on the strength of the balance sheet rather than the debtor book, is even more vital.
What to do when invoice discounting under performs
Don’t wait for this to happen!
Every business should have a working capital toolkit in place. This may include a number of different tools, but what is vital is that it includes two specific things:
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A tool that looks up the supply chain (invoice discounting); PLUS
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A tool that looks down the supply chain (supply chain finance)
In this way, the business has full control of their working capital position, and the flexibility to deal with uncertainty in the supply chain.
Typically, invoice discounting under performs in periods of change – when trying to grow for example; in the face of unexpected market changes; or when stocking up for a peak season.
When a business needs a solution quickly, they need a partner that is also able to act quickly.
Not to replace invoice discounting, but to complement it.
In this situation, the combination of invoice discounting with supply chain finance could even be seen as the perfect marriage.
TradeBridge Corporate
Predicting what’s coming isn’t easy. That’s why we help entrepreneurially-minded businesses like yours to unlock the funding you need to seize new opportunities. We pay your suppliers on their set terms (or earlier), and you repay us on an agreed future date, freeing up cash.
