Lots of businesses could benefit from financial help of some kind, whether it’s extra funding for growth or regular cash injections to balance cashflow. Could invoice finance be the answer?
Invoice finance is growing in popularity as a simple solution to a variety of financial funding needs, yet many business owners are unsure whether it is a good idea. The concept often brings to mind the days when this type of finance was used primarily for companies in financial difficulty, and while the association doesn’t apply any more, mud does tend to stick.
It is true that invoice finance in its two forms – factoring and invoice discounting – has both pros and cons, but often the cons are apparent only because it turns out to be the wrong type of finance for a business.
Businesses that offer customers credit can run into trouble even when the company is performing really well. Late payment of invoices is a notorious problem in the business-to-business sector, and when it happens regularly it can cause an imbalance in a company’s cashflow.
Cashflow can bring even large companies to their knees, but it is those which rely heavily on incoming payments in order to run their business such as wholesalers who must buy more stock or recruitment consultants who must pay their temping staff who are most seriously affected.
Invoice finance in its factoring form enables businesses to get paid on time whenever they issue an invoice. When a business signs up for a factoring facility, they submit their invoices to the factoring company, which advances a pre-agreed percentage of the invoice amount (up to 90%). The factoring company then chases up the customer for payment of the invoice, and once it is paid that part of the loan is completed and the difference passed on to you.
Factoring therefore has several benefits. Firstly, you can be sure of when you will be paid every time you issue an invoice and how much of the payment you will receive. This allows you to plan your cashflow more effectively so you can cover your outgoings each week or month.
Another benefit is that the factoring company will take on the role of managing your sales ledger and chasing customers for payment. This frees up time that would have otherwise been spent on phone calls and letters to customers.
Some business owners become worried that with a third party contacting customers over payment, valuable relationships could be tainted. However, working closely with the factoring company on the nature of the communications with customers, and maintaining your own contact with customers on a regular basis ensures that there are no negative effects.
Invoice discounting is a second variation on invoice finance, generally used by larger companies that need capital funds for growth. Unlike factoring, invoice discounting allows a business to keep control of its sales ledger.
Because larger companies generally have higher sales, they can gain a big cash injection at a comparatively low rate of interest through invoice discounting. This could be used for growth activities and even for management buy-outs or buy-ins.
An advantage of invoice finance as a form of borrowing is that while there is fixed service fee, the interest is only charged on advances that remain unfulfilled by customers. Therefore each time a customer pays their bill, the debt is repaid. Because of this, the amount you can borrow grows along with your business, meaning you don’t have to keep extending your overdraft or re-apply for a loan as with conventional business lending.
The main difficulty with invoice finance is finding a lender that will work well with the needs of your business.
You need to find a company with the same attitude towards managing customers that you have and which will conduct affairs on your behalf with the same professionalism and courtesy. It also helps a great deal to work with an invoice finance company that understands the industry you operate in.
When you and your invoice finance facility aren’t a good match, problems can arise. For example, you might become concerned that the lender is approaching your customers in a way that could be damaging to your relationship with them, or that customers will worry when they receive their bill from a finance company and not directly from you.
These types of problems can be prevented before they appear, simply by working closely with a broker to choose an invoice finance lender and set up the facility. If the broker is impartial, they will know which questions to ask you in order to best understand how your business works and which type of lender your business would flourish under.
Factoring and invoice discounting also work best when the amount of your invoices totals a certain level, so there is a minimum turnover of £100,000 for eligibility with most lenders. This ensures that there are sufficient assets to borrow against. If your business is below this threshold you should be wary if lenders still wish to offer you a facility.
It may seem like there would be little variation between invoice finance companies but in fact, because there are so many of them out there, the gulf between some is wide. It pays to do some research before approaching a broker, so you can say with confidence which companies you would rather not do business with.
If you feel you could benefit from an invoice finance facility, first get some quotes online as this way you can explore the cost with no obligation to take it further.
Simply Business uses a simple form to get you quotes and you can then decide whether you would like to speak to an independent broker about it in more depth. Find it here.
We create this content for general information purposes and it should not be taken as advice. Always take professional advice. Read our full disclaimer
13 August 2020 • 5-minute read
You’ve set up your business and sold goods or services to clients and customers, which means you need to send them an invoice. But how do…
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