Invoice Discounting and the V-shaped recovery

Or will it be a “lazy-U” recovery, or a “W” second lock-down? 

The truth is that right now none of us know how the recovery will play out, other than that the pattern of recovery is inextricably linked to the manner in which restrictions are lifted and businesses are able to start to return to “normal”.

Different sectors will be on different schedules, with different restrictions, and so it is more important than ever to make sure that your business is financed in the most appropriate manner. 

Invoice discounting

Invoice discounting (“ID”) is one of the most common forms of bank lending. Banks like it because it gives them a clear route to the secured asset in times of difficulty, and it is easy to put in place.

If a company has got a reasonably diverse spread of customers, without concentration, then much of the debt book can be offered as security.

In most cases it works by offering an immediate advance against new sales (say, 85% of the face value of the invoice), with the balance being paid to the company when the invoice is actually settled. If the company is making a reasonable profit margin, this equates to getting an immediate advance against the costs of the sale and the business operations, with the profit being received when the debt is settled by the customer. 

When a business is enjoying stable sales, or growth, it works well. The bank facility, which is tailored to the business’s needs, grows as the business grows. So far, so good. 

The drawback

There is a sting, though, which the current crisis will emphasise starkly. 

ID facilities are based on “good” debts – those that are settled within, usually, 90 days. Funds advanced against debts that are not paid within that period are clawed back.

This happens by the debt being deducted from the overall facility limit when it goes beyond 90 days (or the agreed period) and the cash previously advanced is effectively clawed back by the bank through this reduced facility.

The funds already advanced may then exceed the permitted level (if the facility was being fully utilised) and no further funds are advanced until new sales have been made to re-balance the already advanced funds against the revised funds for drawdown. 

You can see the immediate paradox for businesses in the current crisis: At the point that new sales are reducing, which would reduce the ID facility limits anyway, existing customers are holding onto cash and not paying on the due date, which adds clawbacks into the mix. The I/D facility will reduce rapidly through being squeezed at both ends of the sales cycle. 

This is an immediate problem for clients if existing debts are not being paid on time, and it will pose a significant threat as the restrictions on trade are loosened.

The facility will only start to increase as new sales are made, but for those new sales to happen, the business will need to fund wages, materials, and general overheads in advance.

If their bank facilities have been drastically reduced through the ID algorithms, they will not have any cash to fund the working capital needed to get started again. In some cases they will run the risk of going insolvent whilst they have orders waiting to be fulfilled.

If we have a V-shaped recovery with a rapid return to the previous level of activity, businesses may not have the funds they need to get up and running again. 

What can be done?

Many companies with ID facilities will also have general debentures in favour of the bank, and they might also have personal guarantees from the directors as well.

The risk from failure through cash drying up, even when there are orders to fulfill, are significant.

When thinking about your funding, consider the following:

• Was your business profitable beforehand?
• Was the sales ledger tidy, with customers paying on time?
• Do you work in a sector that could “bounce back” after restrictions are lifted?
• Is the business in a complete lock-down, or is it continuing to trade?
• Are your customers at risk of failure themselves, or are they simply trying to warehouse cash by dragging out payment terms?
• Does the business need additional new facilities or simply a relaxation of the ID terms? 

Lots has been written about rescue packages, such as CBILS and these might form part of a solution.

However, if you currently have an invoice discounting facility, think also whether getting your funder to agree to a relaxation of the cut-off date for aged debt will provide some relief.

If they will agree to extend the qualifying period to, say, 150 days as an alternative and to an increase in the percentage of debt funded – up to 100%, it may give the additional room you need.

However, if you can see your sales volumes cycling up and down for the foreseeable future, you might need a funding package that is not entirely linked to your sales volumes.  

For advice on what to do in your situation please contact your usual Bishop Fleming advisor and check out our Coronavirus Knowledge Hub.