Invoice finance means borrowing money against money that customers owe to your business.
Unpaid invoices represent money that will be paid to you but you could be waiting weeks or months until the money is in your bank account if you’ve given them a set time to pay in your payment terms.
Invoice financing can help with your business’s cash flow. By using the invoices as a sort of security against a loan, invoice financing lets you access and use most of the money owed immediately, so there’s no wait to get paid.
There are two types of invoice finance. Both raise the funds against the invoices of your clients but they work in slightly different ways.
With invoice factoring, the lender’s responsible for collecting the debts from your clients, not you.
Payments from your customers will usually go into a bank account controlled by the lender, and your customers will be made aware that you use factoring.
Factoring is lower risk for the lender because it’ll have more control over making sure your customers pay you on time.
This means that lenders might prefer to offer factoring for companies with low turnover, a short trading history, or any other challenging circumstances.
You may also be able to add bad debt protection, which means you wont have to cover the shortfall if your customers failing to pay.
Invoice discounting lets you instantly access cash tied up in unpaid invoices and tap into the value of your sales ledger.
When you invoice a customer or client, you receive a percentage of the invoice total from the lender, giving your business an immediate cash flow boost.
Another way to look at invoice discounting is by seeing it as a series of short-term business loans, using invoices as security. The lender knows that you are owed the money, so will lend you most of it before your customer has actually paid you.
There are a few advantages to invoice finance:
The biggest advantage of invoice finance and the main reason why so many businesses use it. Being able to immediately access the funds tied up in invoices puts your business in a better position invest in new opportunities.
Waiting 30, 60 or 90 days for payments can be costly for businesses, but not offering payment terms that are considered standard in your industry could mean customers take their business elsewhere. Invoice finance lets you extend payment terms to your customers without the detrimental impact it could have on cash flow.
It usually takes a week or two to set up invoice finance for the first time, but once the arrangement’s in place funds can often be released from an invoice within 24 hours of it being issued to a customer.
Unlike other sources of business funding, invoice finance is relatively easy to qualify for. As long as your company has no major financial issues and reliable customers with good credit records, you should qualify. Factoring in particular can be accessed by start-ups and small businesses that might not qualify for traditional credit streams.
As the credit line is based on the value and quantity of your invoices, the amount of funding you can access increases in line with your revenue. It also makes it possible to potentially borrow more than you could from a bank overdraft or loan.
You don’t always need assets as security to set up an invoice finance agreement. In many cases, the only security required is the invoice itself. This can make invoice finance an option for businesses that have few assets and cannot access other financial products.
Invoice finance won’t suit every business and there are a number of drawbacks you should be aware of so you can make an informed decision.
Invoice finance is designed to specifically address the problem of insufficient cash flow. If you have customers that pay your invoices on time and within reasonable payment terms, then this form of finance won’t help you. If you want access to capital to buy new machinery or equipment, then a business loan might be more suitable.
The cost of invoice finance has fallen as competition in the industry increases. But it still might not be the cheapest source of finance for your business. Make sure you get quotes from multiple invoice finance providers by using a whole-of-market broker, then compare the cost against other credit streams.
It depends on whether you choose a factoring or discount arrangement. Factoring providers are responsible for collecting payments from customers and will deal with them directly. This has the potential to affect the relationship with your customers if they perceive the lender to be heavy handed with collection.
Invoice finance won’t be right for every business.
If your company has plenty of cash in the bank already, there’s no point taking out an invoice finance facility as you’ll pay interest unnecessarily.
But if you want to offer your customers longer payment terms while making sure you have enough cash flow to buy stock or materials to start you next job, you could find it wins you more custom and means your business is more profitable because of it.