By David Officen, proCFO
Let’s talk about Invoice Financing. One of the biggest challenges for small and medium-size businesses, especially those which are just starting out, is cash flow. All businesses need cash to pay their employees and suppliers, as well as to put back into the business to finance growth. Unfortunately, customers don’t always pay their bills on time. Often, a business may have experienced a growth spurt or they just don’t have the assets to finance the amount of working capital they need. Whatever the reason, a cash shortage can be dangerous and is the most common reason for business failure.
What is Invoice Financing?
One way to solve this cash shortage problem is for businesses to work with an invoice financing company. There are typically two types of invoice financing – factoring and invoice discounting. Factoring usually involves assistance with both collections and credit and is less common in Australia. Invoice discounting is just the provision of credit against the invoice value and is widely available. Invoice financing companies typically advance a business 80% – 90% of the value of the invoices within 24 hours, with the balance received once the debtor pays the invoice.
In this way, businesses can increase cash flow—to cover payroll, supplies and taxes, for example—when their invoices are past due. The invoice financing company, in exchange for the loan they provide, retains a part of the invoice payment as interest for the loan.
The Pros and Cons of Invoice Financing
Increasing cash flow at critical junctures is an obvious plus for cash strapped businesses, but there are also some drawbacks to this form of financing, and businesses should carefully weigh whether invoice financing makes sense for their specific situation.
Among the benefits of invoice financing are the following:
- Cash is available within 24 hours: the main reason to go with this option is the immediate injection of cash for working capital.
- Loans are easier to obtain: a strong credit history is a problem for many new businesses, and obtaining a traditional loan might prove a challenge. Invoice financing loans generally have a higher approval rate than traditional loans, as lenders are less concerned with credit history than with your ability to repay the debt—and, of course, they hold the collateral of your invoices. The loan process also tends to be quicker, enabling business owners to take advantage of new opportunities which might otherwise not be possible.
- You’ll get help with collections: once an invoice financing company holds your past-due invoices, they can act as a collection agency, contacting your customers so you don’t have to. This frees you from the sometimes difficult task of asking new customers with whom you’re trying to build trust to pay their bills, and means you have more time to focus on more critical aspects of running your new business.
Like any business transaction, invoice financing is not without its drawbacks, including the following:
- You’ll face additional costs: invoice financing companies generally charge a fee of anywhere from 0.30% to 2.5% of the invoice value, and there are often annual fees course there are annual interest rates to deal with. It’s important to carefully calculate both the increased cash flow you’ll receive (including the ways that additional money will help you grow your business) and the cost of fees and interest before committing to an invoice financing company.
- Administration: this type of finance comes with an increased amount of administration as the finance company will want to ensure all invoices and customer payments are genuine.
- You lose some control of customer relations: some of your customers might not like the fact that you’ve sent their financial information to a third-party. In addition, whereas you are likely to treat past-due invoices with kid gloves, a financing company might not be as understanding. It’s important to inform your customers ahead of time about the process, and to be comfortable with the way collections will be handled, before you commit.
Is Invoice Financing Right for Your Business?
Only you can decide what’s right for your business. That said, some types of businesses are better candidates for invoice financing than others. For example, labour hire companies who have weekly payroll expenses but provide 30 day credit terms to their customers. Or a business experiencing rapid growth with customers who provide surety of payment but it may not be until 45 days or more after the invoice is provided.
Your best bet is to get the best possible advice before committing to an invoice financing plan. A virtual CFO has the knowledge and experience to help you work out if invoice financing is a viable option for your business. If you want more information on how a virtual CFO could help you make sound financial decisions to grow your business, contact us today.
About David Officen
David is the Founder and Managing Director of proCFO.
David combines an accounting and consulting background with commercial experience both as a manager for large commercial businesses and as the owner of private and family businesses.