The economic period since 2009 has been remarkable for many reasons. At its heart is the Bank of England’s base interest rate, having hovered around 5-6% in the 90’s and 00’s, dropping to 1.5% in January ’09 and further reducing to an extraordinary 0.1%, today.
What this means is that that for over a decade, borrowing has been an attractive option for consumers and companies and it’s no surprise that the major government schemes that were implemented during the pandemic, such as CBILS and RLS have been in the form of loans to be paid back over time with fixed or variable interest rates.
With rising fuel and food prices, it is widely accepted that we are nearing the end of this period of extremely low interest rates and that at some point soon they will rise, heralding the end of the era of cheap borrowing.
Meanwhile, now that (hopefully) Covid-19 behind us and trading is starting to return to normal, companies need to keep a watchful eye on their cash flow and net working capital (a measure of a company’s liquidity and short-term financial health) - simply put, the difference between a business’s current assets and current liabilities.
A company’s current assets will typically comprise cash, trade receivables (issued but as yet unpaid invoices), accrued income and inventory. As the rate of trading increases, the amount of cash tends to dip as orders need to be fulfilled up to 90 days before they are paid. This creates a strain on net working capital and can be fatal for a company.
Aside from implementing operational improvements to make the cost base as efficient as possible, there is a sure-fire way to improve working capital, and that’s by injecting cash into the business.
There are two ways to inject cash, one is pretty obvious, another less so. The first is to seek external funding, most likely in the form of a loan. This can be a great option, particularly if the cost of servicing the loan (comprising set up costs and interest payments) is more than covered by the income it generates. However, applying for a loan can be time consuming, the costs are rising and unpredictable (as interest is calculated on a daily basis) and the conditions, onerous.
There is another way to access capital quickly and that’s to look within your balance sheet. Every company that is trading pretty well will have capital on its balance sheet that is lying dormant, waiting to be activated and that is those trade receivables - the issued but as yet unpaid invoices. They can be activated through invoice finance. Done well, invoice finance is a powerful instrument to optimise cash flow and improve working capital without extending borrowings.
Like all great ideas, invoice finance is a simple proposition. Rather than having to wait out the payment terms, an invoice finance provider will advance you up to 100% of the value of your invoice (minus their fees) within as little as 24 hours. Although you will not be paid the full sum of your invoice, receiving a significant percentage of it the day after you raise it will be far more valuable than receiving the full amount in 90 or 120 days - by which time you might be in financial distress.
So why do a large number of companies that could take advantage of invoice finance choose not to? It’s partly down to a lack of knowledge of what is available and partly due to market perception.
Established invoice finance providers have historically not done themselves any favours by creating products that are time consuming to apply for, costly to manage and opaque in pricing. When considering a whole turnover agreement, companies have to sign contracts for at least one year. They pay a monthly subscription fee and then the actual cost of funding the invoices on top, with interest charged at a daily rate. Furthermore, the finance provider will take an active debenture over the company, reducing its ability to apply for further funding. Put simply, it looks and feels like a loan even though it is actually quite different!
Thankfully, invoice finance is changing. With developments in technology, particularly with cloud accounting software and open banking, new providers are coming to the market offering more straightforward propositions that are much easier to manage. This can only be a benefit to small businesses; the simpler and more transparent the proposition, the more attractive it will be and the less they will need to extend their borrowings – something I am sure we can all agree is a very good thing.
For further advice contact: h.macandrew@hydr.co.uk or visit https://hydr.co.uk/