Four invented invoice scenarios, and what decided each customer's payout

Four businesses, all invented. Each one found out something about invoice financing that was written in the agreement all along and that nobody reads until it costs them. The figures in each case are also invented, chosen to show the arithmetic.

They are chosen because each one runs into a different mechanism: retention, concentration, fee timing and dispute. If your business resembles one of them, the lesson is probably yours too.

What to take away

The subcontractor and the retention

A small mechanical subcontractor worked for larger contractors on commercial buildings. Its invoices were large, its customers were slow, and it seemed a natural fit for financing receivables.

The first surprise: part of every invoice was not financeable. Main contractors held back a retention against defects, released only months after completion. Take an invented $100,000 invoice with a 10% retention, or $10,000, held back. The financier treated that portion as conditional.

The second surprise was dilution. Variations, back-charges and contra-charges meant invoices routinely settled for less than face value. Say the history shows that 3% of the invoice, or $3,000, settles short, so the financier sets aside that much more. The financeable core is $87,000. At an invented 80% advance rate, the advance is $69,600, not the $80,000 the business had planned on.

The business learned its ledger was not the clean list of debts it had seemed. The remedy was partly commercial: tighten how variations are agreed and documented so that fewer invoices settle short.

The agency and the one big client

A design agency had grown on the strength of a single client that accounted for most of its billing. Its other customers paid promptly; the big one paid slowly, and financing that gap was the whole point of the facility.

Take an invented ledger of $200,000, of which $150,000 is owed by the big client, or 75%. The financier's concentration limit caps any one debtor at 50% of the ledger, which is $100,000. Only two-thirds of that client's balance counts. At the same 80% advance rate, the agency receives $80,000 against that client, not the $120,000 it would receive on the full balance.

The facility therefore financed the small, prompt customers fully, which the agency did not need, and the large, slow one partially, which it did. The agency had three options: negotiate the limit, diversify the ledger, or accept a facility smaller than the problem. It won a higher limit by supplying stronger evidence on that customer's invoices.

The months that bought went to winning two accounts that cut the dependence. The facility did not solve concentration. It made concentration visible, which proved the more useful service.

The staffing firm and the weekly payroll

A temporary staffing business paid its workers weekly and was paid by its clients on monthly terms. The gap was continuous, predictable and growing with every new placement. A whole-turnover facility, financing the entire ledger as it was raised, fitted the shape precisely.

What it had not budgeted for was the cost of its own success. Every new client added invoices, the advances grew with the ledger, and so did the fees. Take an invented fee of 1.5% for each 30-day period an advance is outstanding. On a $50,000 advance, a client paying in 30 days costs $750. A client paying in 60 days costs $1,500. The firm had never priced its clients that way.

It also discovered that the minimum-volume commitment, comfortable at the time of signing, would be a problem if it ever lost a large client. A commitment is a floor the business pays on whether or not the volume arrives.

It started scoring prospective clients on payment behavior and margin, and began quoting terms with the financing cost built in.

A facility that scales with revenue is powerful for a growing business. Its cost must be managed per customer, not in total. It still has to be priced against the terms of a line of credit.

The consultancy and the milestone dispute

A software consultancy financed an invoice for a project milestone of an invented $40,000. At an 80% advance, it received $32,000. The client disputed whether the milestone had been met. The consultancy had chosen a non-recourse arrangement and assumed the dispute was now the financier's problem.

It was not. Non-recourse, in its agreement as in most, covered the client's inability to pay in defined insolvency circumstances. Those circumstances are drafted around proceedings under Title 11 of the US Code, the Bankruptcy Code, such as Chapter 7 liquidation and Chapter 11 reorganization. The federal courts describe those processes in their bankruptcy basics. They do not cover a customer simply going quiet, or a refusal to pay over a quality disagreement.

The invoice came back to the consultancy. The $32,000 advance had to be repaid or offset against the reserve, and the fees that had accrued while the dispute ran were charged as usual. The consultancy paid a premium to protect against an event that had not happened, and had none against the event that did.

Its fix was to tighten milestone acceptance so the client signed off in writing before an invoice was raised. That shortened disputes and made every invoice easier to finance, a habit for the weekly routine in the invoice financing checklist.

What the four have in common

Each business discovered that the financier's definition of a financeable debt was narrower than its own. In every case the agreement said so. Reading the eligibility, concentration, dilution and recourse provisions before signing is the entire difference between a facility that funds the gap and one that funds part of it at full price.

Three of the four also had a sector shape working against them, and how sector shape moves what a lender will do is the subject of loans by industry.

The mechanics behind each of these, from the evidence chain to the recourse definition, are set out in invoice financing. Whether a line of credit would have served any of them better depends on the balance sheet behind the ledger, which is a different question.

Where to check anything specific

Terms, limits and definitions belong to each financier. The FDIC's Money Smart for Small Business covers financing generally with nothing to sell.

Common questions

Are these real businesses?

No. They are constructed to show one mechanism each, and every figure is invented. The mechanisms are real.

Which case is most common?

The dispute. In many commercial disputes the cause is disagreement rather than insolvency, and non-recourse definitions usually cover the second, not the first.

Could the agency have avoided the concentration problem?

Only by having a different ledger. What it could do was find out about the limit before planning around the facility, which is a question to ask in the first conversation.

Is the staffing firm's problem a reason to avoid whole-turnover facilities?

No. It is a reason to price customers on how they pay, which is worth doing whether or not you finance the ledger.