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• 09 May

  A Detailed Explanation Of Invoice Dilutions.

  Invoice dilutions are any factors that reduce the value of a sales invoice. This is important to invoice finance companies as they look to your outstanding sales invoices as security for any prepayment that they make to you.

  Why Invoice Finance Companies Worry About Dilutions

  If an invoice is for say £1,000, you would expect that your customers will pay you £1,000, once the invoice falls due. An invoice finance company will provide funding against that value. If they were to fund at a prepayment of say 85%, you would receive £850 up front (with the balance paid, less charges, when your customers pays).

  However, if something occurs to dilute the value that the customer pays, a dilution, the value received will be less than the face value. The amount that is deducted, determines how diluted the financiers position becomes. For example, if more than 15% of the invoice value is unpaid by the customer, the funder may not be able to collect in the amount that they advanced against the invoice.

  Therefore, dilutions are quantified by funders, before they agree to fund against your invoices and set your prepayment percentage.

  Legitimacy of Deductions

  These dilutions to the invoice value may be legitimate e.g. a dispute due to poor quality, or a discount correctly taken. However, them may not be legitimate e.g. an early payment discount deducted after the invoice fell due. In such cases, it may or may not be something that is able to be recovered. In the case of the early payment discount taken despite the invoice being overdue, the value of the deduction may prohibit recovery of the value deducted due to its size.

  Explanation Of Invoice Dilutions

  Below is a detailed explanation of the various invoice dilutions that can occur:

  • Credit Notes - these are credits to the value of invoices. They may be raised for a number of reasons. It could be that there has been a dispute over the goods or services and therefore a partial credit note is granted. There could be an underlying administration issue e.g. wrongly invoicing, that caused a credit note to be issues. A funder will want to understand the reasons behind any historic credit notes, and to quantify the percentage of your sales that they represent.
    
    
  • Disputes - if some transactions are disputed by customers, due to either administrative errors or disputes over the underlying transactions, a funder will want to identify and quantify those issues. Poor previous performance with customer disputes could indicate that future invoice values may be affected.
    
    
  • Contra Accounts - these occur when there is are both sales and purchase transactions to customers. For example, if a haulage company delivers loads for another haulier customer, on a subcontract basis, but takes fuel from their customer. This can result in both sales and purchase invoices. Whilst the sales invoices appear on the sale ledger, their value is likely to be reduced by the value of any purchase balance, as the customer may choose to offset the purchase balance against the sales balance. This can significantly affect the value of your invoices, so funders are very cautious about such invoices.
    
    
  • Discounts - these reduce the value of an invoice by a fixed amount, or a percentage of it's value. They may be given for early payment, or they could be retrospective volume discounts for reaching certain purchasing volumes. Either way, a funder will want to understand the reason for any discounts and to quantify the possible dilution of the sale invoice value.
    
    
  • Sale or Return - this is where a customer is given goods that they can return, if the are unable to sell them. This potentially devalues your invoices completely, as in a failure situation, a customer could choose to return all of your goods to offset against the value of your sales invoice. Despite the difficult nature of this situation, we have been able to arrange funding against sale or return invoices, where there has been a substantial debtor and an established track record.
    
    
  • Contractual Obligations - funders like simple "sales and forget" transaction e.g. selling a box of products for a set price. However, not all businesses work like that. In some cases there will be underlying contracts that govern the transactions, and can place further obligations upon a supplier, even though they may be able to raise an invoice for a part of a project. We have specialist lenders that are able to value these contracts and set appropriate prepayment percentages, even funding within the construction sector.
    
    
  • Tax Deductions - sometimes customers are obliged to deduct tax from invoice values, this can affect the construction sector. Any reductions to the invoice value will be considered by a funder when setting the prepayment percentage.

  Debtor Quality

  It is also worth adding a note on debtor quality. Even if there are no dilutions identified against the value of your invoices, funders will be very interested in the quality of the businesses that are your customers. What they are looking for are stable debtors that are unlikely to fail or be unable to pay your invoices due to cash flow issues. For this purpose they may assess your customers based on a number of measures, they may also set credit or funding limits against those customers to limit the amount of funding against any particular debtor:

  • Debtor Spread - if you have a wide range of customers, all with small account balances, it is unlikely that they will all fail at once so a funder will draw comfort from this.
    
    
  • Financial Position - funders will often look at previous financial accounts, and in some cases even management accounting information, in order to assess the financial position of a customer. They may also access credit reports on your customers that can also include payment track record information about businesses. 

  By Glenn Blackman