As the vaccine roll-out continues, businesses are looking forward to a return to some kind of normality and a chance to grow that's been held back following the economic uncertainty over the last year. This period of growth will be welcome but, as any experienced business leader or adviser will tell you, increasing activity levels can often present a new type of challenge.
A focus on top-line improvement and a growing order book can result in increased cash pressure. Generally speaking, costs must be incurred before delivery of the product or service, let alone payment of the associated invoice.
This cash pressure can present a challenge during any period of growth. Following a period of depleted trading, many businesses are likely to be entering this phase of growth with weakened balance sheets and cash pressures compounded by the need to repay tax arrears and increased debt-servicing costs from government support measures.
A business must give itself the best possible chance of being able to take full advantage of the opportunities ahead. To do this, it must ensure it mitigates the potential working capital pressure that such growth may cause. One solution to improving the working capital position will be an appropriate invoice finance facility.
The key here is "appropriate". Like many funding solutions, confidential invoice discounting (CID) facilities come in a variety of shapes and sizes, with a range of facility terms that influence the ‘formula’ that underpins the headline advance rate.
Successfully funding growth will depend on identifying the right funding partner to provide the optimal facility structure and fully understanding the facility terms in order to minimise cash lock-up in your business.
So, what is cash lockup?
The main purpose of a CID facility is to contribute to a reduction in working capital lock-up, releasing what might typically be between 70% and 90% of the value of a sales invoice upon issue.
However, the headline advance rate becomes almost unattainable for many businesses. The key metric becomes the ‘effective rate’, a marked down (in many cases, materially so) version of the contracted advance rate agreed with the funder.
This variance is locked-up cash. The funder wants to lend it, and the business wants to borrow it, so what’s the problem?
When it works well, the CID facility is an extremely effective source of working capital funding. However, the formula underpinning a CID facility has numerous moving and often restrictive parts.
When a business is cash positive, these parameters are often overlooked, with many businesses often unaware of their existence and unconcerned that the effective rate is some way short of the contracted advance rate.
However, at times of increased cash pressure, businesses will look to the CID facility and try to understand why it isn't operating as effectively as they understood it would.
In order to optimise the usage of the facility and get closer to the headline advance rate, it's crucial that you have a clear understanding of the funding formula and how certain actions can influence the level of funds available to you.
CID facility restrictions
Restrictions placed on a CID facility are bespoke to each facility, but generally they fall into the following categories:
- Ageing of debtors
- Customer concentration
- Customer funding limits
- Specific exclusions, for example overseas debt
- Contras
- CID facility limit
Eight ways to optimise your CID facility
It's imperative for the business to be aware of the facility parameters and the impact on the business both now and in the future. Carrying on trading as normal and accepting new orders may actually, in some cases, worsen the working capital position. However, being aware and understanding the actions to take (or not to take) will not provide a solution alone. In many cases getting the most from the facility requires a shift change in behaviour.
Below, I've set out eight key areas to focus on to get the most from your facility:
1 Dynamic and accurate forecasting
To make the most of the CID facility, a dynamic forecasting tool is required that models trade and working capital, along with modelling the impact of operational-level decisions.
For example, should we be consciously breaching a concentration limit and what is the cash impact of this or of early settlement discounts?
Invest in a financial model that can quickly and easily be manipulated to help support such decision making, so that cash pressure is identified and appropriately mitigated.
2 Understanding the impact of growth
Businesses, by their nature, tend to be primarily sales led.
For many, the culture is that, as long as the top line is right, then the rest of the numbers will follow. But, this isn't always the case.
Treat growth with caution and consider the working capital implications very carefully. Overtrading can cause as much cash pressure as the alternative.
3 Creating a cash culture
We all know and understand that “cash is king” but how can a business create a cash culture and what does it mean in practice?
The reality is it means different things to different businesses, but one thing is consistent - it requires senior sponsorship. Senior leaders drive behaviour and focus, and the team will follow.
There are many examples, but ensuring the sales team are at least considerate of cash implications, rather than being revenue or profit driven, is key.
Other simple changes could include: daily billing as opposed to month-end, or tighter controls over supply term variations, but the tone must be set from the very top to drive change.
4 Understand and quantify the cash-conversion cycle
At any point in time, there's cash locked up between completion of work and receipt of monies, and a business should be able to quantify this lock up.
While a CID facility itself helps to shorten the cycle, individuals within the process need to understand their respective roles in working towards minimising facility restrictions. For instance, the true cash impact of debtors ageing beyond the allowed term.
5 Focus on the right metrics and monitor
Many businesses focus on simple output measures, such as days sales outstanding (DSO). However, in order to drive behaviour, the input measures are key.
Do you, for example, monitor the length of time to raise an invoice from completion of works? Do you monitor billing accuracy to avoid invoice rejection?
These metrics are key to affecting the output DSO measure in the right way. Make sure there's a relevant suite of input measures in place and monitor regularly and react to the results.
6 Customer relationships are key
Good business relationships are equitable and fair for both sides. Work with customers that agree to terms that work for you both and are prepared to adhere to those terms.
If there's aged or disputed debt, this will need resolving before you continue to supply. If the aged debt is disallowable, then continued trade may result in a cash negative position.
You need to be disciplined and focus efforts on those customers who are motivated to work with you, not on those who want to work against you.
7 Keep communication simple and focused
Employees should be motivated to adopt changes through clear and consistent messages that articulate the practical difference that their actions can make in contributing to a release of working capital lock-up.
Individual performance metrics should be clearly linked back to the main goal. Progress towards these goals should be promoted and celebrated, in much the same way as a new contract win would be.
8 The right funder and the right facility
While general approaches to risk do vary across lenders, the appetite to specific facility terms varies significantly.
For example, one lender may disallow aged debts at 90 days, another at 120 days. Certain funders may simply not like a particular sector or already be heavily exposed there. These variations can have a significant impact on the funds made available from your facility.
Shop around, compare and contrast, or better still seek the guidance of an experienced adviser who will not only test the market for you but also help you to prepare the business in advance of a formal approach and credit submission.
The key to successfully managing a CID facility lies in partnering with the right funder and truly understanding the funding parameters and, more importantly, the impact this will have on cash availability in order to accurately inform decision making. In this way the business can drive behaviours to ensure optimal usage of the CID facility, minimising cash locked up in working capital and giving the business the best chance of taking full advantage of the growth opportunities that lie ahead.
