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How Invoice Finance Companies Calculate Pricing, Charges and Funding Levels

How Invoice Finance Companies Calculate Funding - Initial Payment Percentages

How invoice finance companies calculate the funding percentage (or the initial payment percentage or discount) (early payment percentage means the same thing) that they are prepared to fund against invoices.

Just to clarify the terminology, the full value of a sales invoice is 100% and typically initial payments can be any percentage up to that figure (in rare cases funding can even exceed the value of the invoices if an overpayment is made). The way the initial percentage works is that if an invoice is worth £100 and the factoring company offers 80% funding the client receives £80 immediately (bear in mind there may be some other restrictions applied in some cases), and when the invoice is paid the remaining £20 is passed on although charges are of course deducted. The initial payment is less than the full 100% value which gives rise to the term "discount". Hence discount percentage can mean the difference between 100% and the initial payment percentage (not to be confused with the alternative use of the term "discount" charge which means the cost of the funds charged over the bank base rate).

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The following factors normally affect the calculation of the initial payment percentage by an invoice finance company, the amount of the reductions will vary between providers:

• Dilutions - anything that can reduce the value of the sales invoice that is paid. These could include credit notes, disputes, offsets, contra trading accounts (balance on sales and purchase ledger), discounts offered, sale or return or other contractual issues that might dilute the value of the debt.
• Debtor/customer quality - if the quality of the client's debtors is high the invoice finance company will be more confident in their ability to pay the invoices and hence may fund more. The converse is also true so poor debtor quality may be reflected in a reduction in the initial payment percentage.
• Sector or industry - this can also drive the initial payment percentage, invoice finance companies are very experienced at working within a wide range of industry sectors so they will know which sectors typically give rise to payment issues and they may adjust the initial payment percentage accordingly.
• Debtor spread - a narrow spread of customers is less attractive to the invoice finance company, sometimes other methods of controlling prime debtors or concentrations may be used, such as a prime debtor restriction. However, the finance company may also adjust the initial payment percentage to account for this.
• The ageing of the client's sales ledger - if invoices are tending to become very overdue the invoice finance company may reduce the initial payment percentage.
• Financial stability and track record of the client - if the client has financial problems the invoice finance company may reflect this perceived increase in risk by reducing the initial payment percentage. It is also common practice that reductions in initial payment percentages may be used where clients are not compliant with covenants or conditions that have been placed on the facility.
• Audit trail - the audit trail is the paper trail that follows an order through to delivery, invoicing and then payment. If the paper trail isn't up to scratch the invoice finance company may reduce the initial payment percentage.

Those are the key factors that will affect the calculation of the initial payment percentage by an invoice finance company, the percentage is set at the outset of the arrangement but can be adjusted at any point. Different invoice finance companies will take different approaches to setting initial payment percentages so if you are having funding problems we may be able to find you an alternative invoice finance company that may take a different view in calculating the initial payment percentage.

How Invoice Finance Companies Calculate Pricing, Charges & Fees

How invoice finance companies, factoring companies and invoice discounting companies calculate and set their charges and pricing.

Types Of Invoice Finance Charges

Firstly you should be aware that different invoice finance companies charge differently. Traditionally the charging structure for invoice finance is a service or administration charge (for the service, typically a percentage of turnover or a fixed fee per month), a discount charge (a percentage over base charged on the funding provided and then other charges e.g. electronic transfer charges etc. However, recently there have been several invoice finance companies rolling some or all of those charges into one overall fee which again could be a percentage of turnover or a fixed fee per month.

How Invoice Finance Companies Calculate Their Charges

One of our partners has previously been involved with the construction of pricing formulas within several invoice finance companies. This means that we have an in-depth understanding of how these models are constructed and how they work.

Most invoice finance companies have a pricing formula or pricing matrix of some description. Some are very complicated, some simple. In addition to that, there is often a degree of arbitrary adjustment made to the charges that the formula suggests. This can be based on risk perception, an expected workload or just the desire to win a deal. The pricing formula will also include the return that the invoice finance company wants to make on each deal. Often the formula will require a certain percentage return and the Business Development Managers or Directors (salespeople) will have the ability to adjust the individual cost components within that overall return or yield requirement. 

Examples of pricing for factoring and invoice discounting.

Product-related factors may affect workload. For example, if the client wants bad debt protection the invoice finance company will price for that and the pricing will be driven by debtor numbers, debtor quality, the level of any first loss clause, bad debt history etc. Equally, some invoice finance companies' pricing formulas reflect other product factors such as confidentiality, bulk or individual invoice processing or use of electronic systems etc.

Risk & Workload Factors That Affect Invoice Finance Pricing

The pricing calculation will differ depending on the type of invoice finance product.

Factoring Pricing Formula

For instance, with factoring the factoring company will be undertaking a lot of work in providing a credit control service, hence the pricing formula for factoring may factor in workload factors such as:

• Number of invoices per month.
• The number of live debtors (having a balance on the sales ledger) and in total (including those that don't have current balances.
• Average invoice value.
• The number of credit notes (these can add a processing burden which may affect the pricing calculation).
• Actual and/or Projected Turnover - often pricing formulas will include some kind of rachet for the size of the client - a kind of "discount" for larger volumes.

In addition to workload factors, there may be some risk-related factors that affect the factoring pricing calculation or how it is adjusted (ultimately in extreme circumstances these risks could lead to a decision not to even quote for a deal) such as:

• The perceived risk of client failure may increase pricing as the factor fears the additional cost of recovering their funding from the sales ledger. Conversely, a good financial history could result in an attractive risk proposition that the factor will adjust for.
• Perceived risk associated with particular industry sectors i.e. if factors have had good or bad experiences within particular industry sectors they may adjust pricing accordingly.
• Previous facility breaches by the client - if the client has breached the facility covenants (or the covenants of another factor) before the pricing may be increased.
• Ageing of the sales ledger - if the ledger is old the factor may perceive an additional workload and hence price for that and vice versa.

Invoice Discounting Pricing Formula

With invoice discounting, the invoice discounting company will not be undertaking the credit control and so many of the workload factors that affected the factoring pricing formula may not affect or may have a lesser effect on the invoice discounting pricing formula.

Pricing will normally be affected by:

• Client size - i.e. turnover and volume of funding as described above.

The other factors noted in the factoring section may have a slight effect on pricing as they would increase the cost of a collect-out in the event of client failure, however, they will have little effect on the day-to-day workload and hence a lesser effect on cost. Some invoice discounters may not make any adjustments for some of these factors.

The risk factors described in the factoring section above could all equally have an effect on invoice discounting pricing calculation and the invoice discounting company is likely to be more concerned with the client's financial accounts and position than a factoring company. In addition, there may be other costs that are included in the invoice discounting pricing formula e.g. regularity of audits. This may be driven by the risk policy of the invoice discounter and in some cases the pricing may be adjusted to account for the regularity of audits, this may not be the case for all invoice discounters though.

Invoice Finance Pricing Models

As I mentioned above the construction of pricing models and pricing calculations differs vastly across the industry. In some cases they are very simple and take account of very few of the factors mentioned above, in other cases the opposite is true.

You can use our independent invoice finance quotation search without any obligation to proceed: REQUEST INVOICE FINANCE QUOTATIONS