Invoice finance: the solution to your cash-flow problems?
Simply put, invoice finance is a way of raising cash for your business, where a third party pays you an agreed amount set against an invoice or invoices you’ve issued but that are yet to be paid.
Because the sales ledger is often the largest asset on a company balance sheet, raising finance against invoices is a ‘safer’ vehicle for lenders to use and can provide quick and relatively stress-free access to cash.
This quick guide covers the whys and why nots of invoice financing.
Before you decide
Invoice financing can be a great help if your business is suffering from cash-flow problems as it’s a quick and well-established way of getting money into your bank account. The downside is that the finance company you work with will take a fee and/or a percentage of the value of the invoice, which will reduce your income over the long term.
Key advantages of invoice financing
- There’s a wide range of companies operating in this market, looking to lend to small businesses.
- It’s more flexible than traditional loans or overdrafts.
- Decisions can be made quickly, meaning the money gets to your bank account sooner.
- Lenders are often prepared to lend larger sums against invoices as it’s a smaller risk to them.
- The lender will often agree to ‘chase’ payments from clients or customers on your behalf.
- The ‘red tape’ is far less involved than with traditional business loans.
Key advantages to lending companies
- There’s a wide range of credit-worthy debtors.
- The goods or services invoiced for have already been provided, meaning there’s a low level of disputes and a much-reduced risk.
Many lenders in this sector are not regulated by the Financial Conduct Authority (FCA). Because of this borrowing firms need to research potential partner firms thoroughly.
You should make sure that:
- All fees etc. that you’ll be charged are transparent so you know exactly what you’re paying and when.
- The contract lasts no longer than 12 months.
- You know how to exit the agreement without incurring excess fees or charges.
Other things to think about
- You must do business with other businesses, not consumers, to qualify.
- You must be an LLP or a limited company.
- Most lenders won’t do business with companies with a turnover of less than £50,000 a year.
- Ideally, it should be used as a short to medium-term funding solution. If your business relies on invoice finance in the long term, this may be masking underlying problems.
- It isn’t always a suitable alternative for an overdraft. This particularly applies to a seasonal business that requires cash flow support year-round.
Types of invoice finance
The different types of invoice finance available are designed to appeal to different types of borrowers.
Invoice factoring – or ‘factoring’ – is a good way for a company with a poor credit history to improve their cash flow. Unpaid invoices (accounts receivable) are sold to a third-party factoring company. They buy the invoices for a percentage of their total value and then collect the invoice payments themselves. Invoice factoring is a good way for businesses who have long payment terms to raise funding.
Invoice discounting is a good way for companies that are growing to raise funds against their invoices owed. For every invoice sent to a customer, part of the amount invoiced becomes available from the lender.
Invoice discounting is generally made available to companies that have a stronger balance sheet and well-established systems that the lender can audit on a regular basis.
Invoice finance is usually based on a whole turnover agreement where all sales on trade terms are assigned to the lender. But some specialist funders will fund selected invoices – normally those to blue chip companies where credit terms exist for good already delivered.
Charges and fees
A service fee is added as a percentage of turnover, as well as a discount charge, which is the equivalent of interest. Invoice discounting is usually cheaper than factoring as there is less administration required.
Credit protection is costed as a percentage of turnover and will usually be added to the service fee.