Invoice financing for small business is an umbrella term used to describe financial options whereby companies can on-sell their accounts receivables to a third party at a reduced amount of the sum total owed.
How Do Invoice Financing Companies Work?
Invoicing financing companies deliver advantages that make them a valuable service to the business community.
SME’s are always vulnerable when payments are slow in coming. Especially now that the government is winding down the popular COVID-19 related assistance loans. A sluggish cashflow is anathema to business growth, especially in a stumbling economy brought on by a pandemic. The faster a company can rectify its cash flow challenges, the quicker it can return to running at full capacity.
In general, an invoice financing company will pay a reduced amount of the total for unpaid invoices. The financing terms will vary depending on the amount owed and the financing company’s assessment of the loan risk.
The invoice financing company pays your company an agreed percentage for the outstanding payments – usually between 80 and 90%. Depending on the arrangement, your company can continue with payment collection, or the financer can take it over for you.
When the invoices have been paid, your company receives the outstanding amount, minus the agreed-upon percentage and related service fees.
What are the Different Types of Invoice Financing for Small Business?
There are two main types of invoice financing available to SMEs:
Invoice Discounting is an invoice financing technique where the lender immediately pays a percentage of the funds locked away in unpaid invoices. Your company then continues to seek payment from the debtors per its usual methods. Once debts are collected, the lender advances your company the outstanding percentage, minus the agreed service fee.
Invoice Factoring is the most used type of invoice finance used in the UK. It’s similar to invoice discounting, but with one main difference. Invoice factoring transfers responsibility for credit collection to the lender, who then pursues the debtors for the payments.
The main advantage of both invoice financing types is that your company receives an immediate cash injection. As oppose to waiting 30, 60, or 90 days for payment.
Within each sphere of invoice financing for small business, there are other variants that invoice financing companies can provide as a service, including, but not limited to:
CHOC, or Client Handles Own Collecting.
This method sits in between factoring and discounting. Your company retains full control of its invoices and collection strategies. But discloses to your customers that an invoice financing company is now involved.
Your company receives a cash injection from the invoice financing agreement. But the lender’s involvement is kept confidential, so debtors remain unaware of the changed circumstances.
Your company receives the advance on outstanding invoices. But the arrangement is revealed to the debtors, so they know of the invoice finance company’s involvement.
Your company sells your invoices to an invoice financing company. But with an agreement that it will buy back any that remain unpaid. The lender then funds unpaid invoices for a set number of days past their due date. If customers don’t pay, then your company will cover the cost.
This invoice financing variant is similar to recourse factoring, but the lender takes full responsibility for unpaid invoices. Lenders will often refer to non-recourse invoice financing as ‘bad debt protection’. This financial strategy is always associated with higher invoice financing rates due to the increased risk.
This type of invoice financing allows you to selectively choose which invoices you wish to finance rather than hand over your entire ledger. You get extra flexibility in how you handle your slower paying customers or those with extended credit terms.
Should You Choose Invoice Factoring or Invoice Discounting?
As briefly discussed above, the critical difference between factoring and discounting is that factoring puts the role of debt collecting into the invoice financing companies’ hands while discounting keeps it within your organization.
If you have concerns about how clients will perceive a third party collecting on your invoices, then discounting may be the more prudent course of action. You are much less likely to ruffle feathers and lose valued clients with invoice discounting while still retaining the advantages of improved cash flow.
How Do Invoice Financing Companies Buy Invoices?
Invoices are usually bought over two installments: the advance and the remainder. The ratio most invoice financing companies use for invoice factoring are in the realm of 80% for the advance. With the remaining 20% rebated once payment is received from your client. The lender will also take their fees out of the rebate repayment as a service charge.
How Much are Invoice Financing Rates?
The costs can vary between invoice financing companies. In general, invoice financing rates are usually within the range of 1.5 – 5% of the invoices you are financing each month.
What are the Advantages of Using Invoice Financing Companies?
Most companies operate on a 30 or 60-day credit system, which can sometimes produce cash flow challenges. Invoice financing can help shorten the gap between when you make a sale, and the time you receive payment. Instead of waiting 30 or 60 days for payment, invoice financing delivers immediate access to working capital without a typical loan’s long-term commitment.
Payments with invoice financing only fall due when your clients bring their invoices up-to-date. You also incur no interest charges and only pay the fees to which you agreed.
When you have money tied up in a big project with a bad debtor, poor cash flow may mean you have to pass on other lucrative contracts. Invoice finance can give you the cash injection you need to keep growing your business, without stretching your resources too thin.
Invoice financing is a much faster method of accessing funds than a loan application. While a typical bank loan can take weeks before giving you access to the funds, invoice financing companies can provide it in less than a day.
Invoice financing for small business
In an unreliable economy, it’s always good to know that you have options for keeping your business viable. Invoice financing companies provide a fantastic opportunity for improving your cash flow. However, always do your due diligence before selecting a provider to ensure you get the best deal for your situation.