By Roman Itskovich, VP of Financial Products, Ebury
Me: “How much are you paying for your invoice discounting?”
Client: “Base + 3%”
Me:“ Service fees? Setup fees? Minimum fees?”
Client: “I don’t know”
5 minutes later…
Client: “Are you really telling me my effective APR is 30%?!”
Sounds familiar? Because for this happens daily for us. It’s no surprise then that there is a government push to regulate invoice discounting, and small business lending. Hidden charges can make small business lending up to 10 times dearer than the headline price business owners think they’re going to pay. Here are the questions that will help you avoid this common pitfall:
How much will be the cash cost for a client like me?
Understanding costs is paramount, but often hard to do. It’s important to spend time really understanding how much it will cost. Most businesses I talk to are oblivious of the various fees charged to them, because they are happy with the headline price. That’s a mistake – financing can prove to be very expensive unless one goes under the hood and tries to understand the pricing. Time spent on this, is literary money saved.
Cash is king, percentages don’t matter. Financiers know that, and that’s why they talk percentages – because those are hard to compare between sources of financing. The only real way to understand the actual cost is to ask for how much in cash will a client like me pay. That’s it – understanding how much cash it costs is how you make sure all the fees are included and nothing is hidden.
Forget headline price, calculate the real annual interest rate. For a one year £100,000 loan with a 4.5% headline price, £1,000 setup fee,1.5% service fee charged of the whole turnover (£500,000 in this case) this will amount to 17.5% APR – 5.5 times higher than the headline price!
When do I get the money?
Many businesses use invoice discounting and other facilities to advance cash to the business. As working capital creates drag on growth – advancing cash, even at a high financing cost, is the sensible thing to do.
Ask your finance provider about the timing of cash advance, and the fees to figure out cash flow impact. Many policies will ask you to pay fees upfront and only advance a portion of the invoice discounted that be as low as 70%. That together with the fees, can mean that you’re paying for a full 100% loan, but getting only 50% of the cash upfront.
Make sure you understand the cash flow implications. Sometimes this means that more expensive facilities that advance more cash will actually help your business capture those lucrative growth opportunities much better.
How much will it cost if I don’t use the facility? Can I break early?
No one knows when opportunity comes. Opportunity may demand more cash, like one of our customers got last month when he was able to purchase stock at 50% discount from a cash squeezed supplier. Or opportunity that throws out cash, like one of our customers that sold 500% more than budgeted in August because his brand of backpacks got trendy.
Are you able to expand your facility quickly? How much will it cost if you don’t use the facility? How high are breakup fees?
In some cases, this all doesn’t matter – when you know you’ll be fully using the facility through the year. In other cases, you might be paying the full fees, while keeping cash in the bank not being able to use it to pay back lending because of minimum fees, fixed setup fees, and high breakup fees.
Invoice discounting is much more expensive than you think, because of hidden fees. It’s not because its complex, it’s because that’s how financiers make money. Spending time on actual cash costs and flexibility can mean serious savings and real comparison to other sources of funding.
Don’t let the cash costs surprise you, figure it out!
Roman Itskovich is the VP of Financial Products at Ebury, a company that helps UK and Dutch business trade internationally