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Why is invoice finance and the bank like oil and water?

Supplier: AR Cash Flow
11 September, 2009

To answer this question we may as well take a short trip back through time.

Invoice financing dates back some 4,000 years (that’s right it is almost time immemorial) to King Hammurabi ([1795-1750 BC]) who ruled ancient Mesopotamia. You might know him as he established the greatness of a little town known as Babylon i.e. the world’s first metropolis.

The Mesopotamians are noted as the first people to put some sort of structure into business in the form of a code or laws with government regulation. The Mesopotamians also invented invoice finance.

These ancient laws were of course very crude and included such punishments as ‘an eye for an eye’.

The laws of society have obviously developed somewhat since then, yet for some very good reasons invoice financing has remained. Through more recent history you can see when invoice finance has risen into promenence time and time again;

  • The Romans sold discounted promissory notes
  • American colonies, prior to the revolution used it to finance goods like cotton being shipped from European colonies to the Americas (no banks like todays back then)
  • During the Industrial Revolution factors guaranteed payment for approved customers. In the USA factoring was primarily used in the textile industry
  • The private factor became extremely popular during the 60s, and 70s when interest rates rose. During the 80s changes in the banking industry continued this uptrend as small business were forced to look outside of banks for funding.

Today once again banks are being forced to squeeze SMEs and only fund those businesses with excellent profitability and substantial amounts of bricks and mortar backing.

As a result, the demand for invoice finance is now stronger than ever.

Why can an invoice financier finance a business when a bank can’t? Why have certain banks tried to do it and failed?

The simple answer to this is because banking institutions are not equiped (nor do they want to be) to deal on a day to day basis with business. As an invoice financier, the only way to fund a business that has a floating asset base (the floating asset base being the accounts receivable), is to monitor it on a day to day basis. And the only way to monitor it daily is with a high level of interaction between the invoice financier, and the business being financed. This clearly does not fit with the banking model.

Now do you see why banks don’t do invoice finance well? Now do you understand why banks try and then fail? If you still don’t then let me go on…. Banks are always looking to reduce costs (as all good businesses should do), and a great way to do this is to reduce the amount of interaction between the client and the bank. However, in invoice financing, this is a major problem. Why? The simple answer is that invoice finance is substantially based on integrity and a good partnership. To ensure that this is occurring you need interaction.

If you reduce the amount of interaction between the client and the financier, then this relationship becomes wide open to abuse, not only from the bank’s side, but also the from the client’s side as well. What we have seen recently is the bank comes in with a wizz bang computer system that means they don’t have to use people to do the integrity checks, then they lose a truck load of money, then they pull out of the market leaving their clients who do have integrity high and dry. Some of our current clients have first hand experience of this prior to becoming a client.

As a long time invoice financier once told me; “If you give somebody the keys to your piggy bank, you want to make sure they know you are keeping an eye on it”.