Cashflow management and business financing

23 Aug 2023

man and woman sat at table discussing finances

In recent articles, we’ve explored how businesses can better manage cashflow from the perspective of business taxes and VAT. Ongoing high inflation and global political and economic instability continue to provide a volatile backdrop for the operations of many businesses. This can be more significant for small and medium-sized enterprises (SMEs) and owner-managed business, which can find it challenging to manage working capital stakeholders or arrange appropriate financing.

In this article, we explore some of the financing arrangements available to businesses to assist cashflow management.

Good business practices

Before seeking advice, there are a number of good business practices that could be adopted by any company aiming to optimise its working capital management and cashflows.

For example, a company could explore modifying current credit terms with both their suppliers and customers, to make full use of its existing relationships. Where there are established relationships, these stakeholders might be amenable to discussions around payment terms, especially if this is framed in the context of the optimisation of the services supplied.

Another example of this could be to explore longer-term contracts for preferential rates and terms. For lesser established relationships, the company could consider exploring alternative suppliers providing equivalent services on possibly preferential terms. The company could feasibly then leverage from discussions with alternative suppliers to make its existing terms more competitive.

Proactive working capital management

As a company grows, it should look to implement improved credit control processes and proactively chase outstanding invoices from debtors. Automated statements on account and follow-up’s can be set-up to reduce internal administrative burden whilst ensuring engagement with customers. In addition, the company could potentially consider early settlement incentives in order to maximise cashflows.

For businesses that hold inventory, a review of the levels of stock required for operations could yield benefits. Reviewing ageing inventory lines and days calculations could highlight where there are working capital inefficiencies. Where customer relationships require a minimum level of inventory to be held by the company (which it then effectively finances), customers should be open to negotiating a quid pro quo for favourable payment terms.

Timely and accurate management information alongside active budgeting and forecasting are crucial to highlighting the potential issues in the company’s working capital cycle. Most trading companies’ management information should include monthly reporting covering profit and loss, balance sheet and cashflow statements. In addition, key performance indicators (KPIs) and comparisons against budgeted performance should emphasise where the business performance has changed month on month, or where changes against expectation have arisen. Both can then be used to identify corrective measures which can assist in working capital and cashflow management.

Invoice discounting

For a company where payments are made to suppliers prior to cash being received from customers (ie a company with a positive working capital requirement), a working capital facility, such as invoice discounting, might be appropriate. For example, this arrangement is commonplace in temporary recruitment agencies, where cash needs to be received to pay worker salaries. Typically, a business’ working capital requirement will scale with the level of trade, therefore an invoice discounting facility can also be used to facilitate growth.

Invoice discounting is where the company arranges a facility with a bank or alternative financing institution, through which the financing entity advances the company a high percentage of its debtor balances in cash as a loan, using the company’s debtors as security.

This arrangement allows cash to be received by the company in advance of the stipulated credit terms. The cash received from the customer is then used to settle the loan provided by the financing entity in addition to a fee for the arrangement.

Invoice discounting arrangements are typically priced on the following bases:

  • Interest paid on the amount borrowed from the factoring entity,
  • Servicing fees associated with ongoing management of the facility, and
  • Certain other arrangement, cancellation, and ancillary fees.

This arrangement is usually anonymous, so the customer will not know that you are using their invoices as security for financing.

Invoice factoring

Invoice factoring is similar to invoice discounting in that it provides early cashflow against your customer debtor balances. The distinction here is that the financing entity purchases the debt and therefore typically maintains the credit control function as well.

This means the financing entity will deal directly with customers for debt collection. This might be appropriate for a company with the need for working capital finance that also wants to outsource its credit control function. However, the company will need to consider whether the impression it creates with customers is worth the benefit of the arrangement. Ultimately, the company will lose control of the credit control process and aspects of customer relationship management.

Another difference is that invoice factoring is likely to be more expensive due to the more extensive services being offered. However, the additional services, such as outsourced credit control, credit checks and ledger management, may be cheaper than employing someone internally, or may free up time of management.

A further consideration is credit risk management. The financing entity in a factoring relationship will likely run credit checks on prospective customers, actively engage with late paying customers, and as such reduce the company’s exposure to credit risk.

Factoring can be arranged on different terms. At a high level, these arrangements can be grouped into ‘with recourse’ and ‘without recourse’.

Factoring with recourse

Factoring with recourse effectively means that if the company has a customer that does not pay its invoices, then the company is still liable to fulfil the payment to the financing entity (the financing entity has recourse).

The pricing structure of these arrangements is typically consistent with that of an invoice discounting facility. However, the servicing fees tend to be greater than for a discounting arrangement because management of the ledger is undertaken by the financing entity.

The benefits are largely consistent with a discounting arrangement. The cost is more as the service provided is more extensive. In addition, consideration needs to be given to the impression created by the outsourcing of the credit control function to a financing entity.

Factoring without recourse

Factoring without recourse means that the financing entity takes on the risks and rewards of ownership of the debt.

These arrangements are riskier to the financing entity; therefore, they tend to be less commonplace and require further credit checks and diligence to set-up. Pricing is consistent with that of the ‘with recourse’ arrangements, however there will be an additional credit protection charge. Typically, this will be determined as a percentage of company turnover, with the percentage driven by the perceived risk of the customer portfolio.

This arrangement mitigates bad debt risk but should be weighed up against the additional cost of using such a facility. This type of arrangement might be ideal for companies that have a few large and low risk customers, for example companies with large government contracts.

Reverse factoring and supply chain finance

These arrangements are similar to factoring without recourse, with the difference being that the contractual arrangement exists between the financing entity and the company’s customer in respect of payment of the company invoices.

These arrangements are usually entered into where the company provides services to a large credit- worthy customer who would command a high degree of power in the relationship, and therefore would instate long credit terms, but with low credit risk.

The size and nature of the customer in question can put strain on the company’s working capital management, but from the perspective of the financing entity, it’s an ideal set of debts to factor.

Therefore, at the company’s request, the financing entity and the customer enter into a factoring arrangement. This provides immediate payment of company invoices by the financing entity and low risk settlement of debt from the customer over the typical credit terms.

These arrangements require robust systems and controls for the real-time assessment of invoices for payment. Any type of arrangement without recourse will only be applied discerningly to selected suppliers after sufficient due diligence is undertaken.

Since the relationship exists between a large customer and a financing entity, it effectively gives a small company access to financing it, which otherwise would be unachievable. The customer at the same time maintains longer credit terms.

Export credit and UK Export Finance (UKEF)

If you’re a UK company offering products or services to overseas customers, you could consider the financing options offered by UKEF. UKEF products are designed to ensure that viable UK exports are made, by ensuring that appropriate financing is in place for a UK company, an overseas customer, or an appropriate guarantee is in place for an overseas financing entity.

The UKEF is a ministerial department of the UK government and can potentially provide one of the following:

  • A loan guarantee to a financing entity offering finance to an overseas customer of the UK company,
  • Direct lending to overseas customers,
  • Guarantees to your financing entity to allow you access to larger financing facilities, or
  • Other financing products, including export insurance, supply chain financing assistance, or facilitating bond guarantees.

Standard Buyer Loan Guarantee (SBLG)

With an SBLG, UKEF provides a guarantee to a financing entity providing a loan to an overseas customer of a UK company. This will allow:

  • The financing entity to get additional security against its loan to the overseas customer,
  • The overseas customer to get its finance from the financing entity, which it pays back to over time,
  • The UK company to get paid on a timely basis using the funds from the loan offered to its customer, and
  • The UKEF to ensure that viable UK exports continue to trade overseas to the benefit of the UK economy.

There are certain conditions which have to be met in order for UKEF to provide the guarantee. For example, the contract value must be 20% UK content (goods and services arising in the UK) and the exporting company must be carrying out business in the UK. Additionally, the total contract value must be in the range of £1 million to £30 million, whilst the financing entity needs to be approved by the UKEF, and the customer needs to be operating in an approved jurisdiction.

General export facility

With a general export facility, UKEF will provide a guarantee to your financing entity to allow you access to larger facilities otherwise unavailable to you. This is with a view to increasing the company’s and the UK’s exports.

In this arrangement, you need to demonstrate that 5% of your annual turnover has been export sales in each of the three last years and was 20% in one of the last three years. If approved, a company can receive up to £25 million in finance, repayable over up to five years.

Other UKEF funding options

There are various other facilities offered by UKEF, from larger guarantee schemes to export insurance and direct lending. For further information, see the UKEF website.

We have extensive experience of supporting businesses with their cashflow and financing arrangements. For any further queries on the points raised, please get in touch with Niraj Patel.

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Niraj Patel
Partner, London

Key experience

Niraj is head of the firm’s Corporate Finance Team and advises clients on transaction support and business advisory assignments.