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Invoice Finance

Shaun McGowan By Shaun McGowan
If you need some funds to bridge the gap between issuing an invoice and getting paid (which can often be 30+ days), and you do not want to borrow money (go into debt), then invoice financing may be a great solution for you! Invoice Financing

What is invoice finance?

Invoice finance, also called ‘factoring’ or ‘accounts receivable’ finance, is a short-term, non-debt finance option.


It involves selling your unpaid invoices to a third party (a factoring company), providing an instant cash boost to your working capital.


The factoring company will then collect the debt from your customer when it falls due.


Usually, the factoring company will provide you with a cash advance of 70-90% of the value of your invoices up front.


When the factoring company collects payment, they will then deduct a percentage for their fee and transfer the balance to you.


Invoice Finance Process

Invoice Finance, also known as factoring, is a type of non-debt business finance. A factoring company buys your unpaid invoices and advances you 70-90% of the value of your invoices. They will then collect payment from your customer when it’s due and pay you the remainder less their fee.


Who uses invoice finance?

Invoice finance is a popular option with businesses that don’t qualify for a business loan.


But it’s only an option if you offer credit terms to your customers, since it involves selling your unpaid invoices to a third party.


Invoice finance providers will look at the creditworthiness of your customers rather than that of your business, because the level of risk involved depends on how quick and reliable your customers are at paying their invoices.


Invoice Finance - Customer Credit Rating

This means that you may find it easier to access invoice finance rather than get a loan if your business has a poor credit rating or if you haven’t been in business for very long.


Some businesses use factoring because it is not debt finance, and does not, therefore, have to be recorded on the balance sheet. This means it won’t impact your capacity if you also plan to apply for debt finance.


What is the purpose of invoice finance?

The main purpose of invoice finance is to eliminate the gap between the cost of making a sale or providing a service, and receiving payment from your customers or clients.


Invoice Finance - What is the purpose

Since cash flow issues are the primary reason small businesses fail, invoice factoring can be a very valuable tool, enabling you to keep your working capital steady and meet expenses as they fall due without relying on your customers to pay on time.


For some businesses with high cost of sales, invoice factoring can make it possible to offer credit terms to customers without running into cash flow problems. This could give you a valuable competitive advantage in some industries.


Invoice factoring does not give you extra funds to invest in your business – it simply brings forward the receipt of payment. You can use the proceeds in the same way you would if you’d waited for payment from your customers.


How much does invoice finance cost?

Invoice finance can be an expensive option – more costly than some other forms of short-term finance – although the cost will vary depending on the type of factoring you choose, the length of the credit terms you offer, and the creditworthiness of your customers.


Factoring fees are charged as a percentage of the invoice amount – typically between 1.5% and 4.5% per 30 days outstanding on the invoice.


The first decision you’ll have to make, which will have a big impact on the cost, is whether to opt for recourse or non-recourse factoring.

Non-recourse Factoring

With non-recourse factoring, you won’t have to worry about the invoice again once you’ve sold it. The factoring company will take full responsibility for collecting the debt, and if your customer fails to pay all you’ll lose is the small percentage balance payment due on collection. Since this form of factoring is higher risk to the provider you can expect to pay a higher percentage fee.

Recourse Factoring

Recourse factoring is generally cheaper, because the factoring company can force you to buy back any invoices they are unable to collect after an agreed period. This means that you will have to pay back the advance you have received, potentially plus an administration fee – and that you will have to take the loss if your customer completely fails to pay.


Invoice Finance - Recourse and Non-Recourse

The other issue which has big impact on the cost of factoring is flexibility.

If you are happy to sell all your invoices, or all invoices for a specific customer, then you can generally get better terms than if you want to pick and choose when, and which, invoices to factor.

Do you sell ALL your invoices or only some?

With ‘whole ledger’ factoring you will enter into a bulk factoring arrangement for a period of time, and you will be locked in even if you don’t need the cash boost some months, or if the arrangement no longer suits your business needs.


‘Spot’ or ‘single invoice’ factoring, on the other hand, allows you to sell selected invoices as and when you need to.


Regardless of which type of factoring you choose, you may find that the provider is selective about which invoices they are willing to purchase – or they may offer you different rates for different customers, based on their assessment of those customer’s payment history and financial stability.

MONEY TIP Money Tip
It’s important to be aware that there may be additional charges on top of the factoring fee. Some providers will charge set-up and ongoing admin fees, and you may also have to pay money transfer fees.

Be sure you know about all the fees before you enter into a factoring agreement as these additional charges can quickly add up.

Where to get invoice finance, banks or alternative lenders?

There are scores of invoice factoring providers in the alternative finance market, and most high street banks offer the service too, if you meet their strict criteria.


Many online lenders (alternative lenders) offer factoring as a service in addition to other forms of finance like unsecured business loans.


Other firms specialise in factoring, and some only work with particular industries or businesses with a particular business model.


Applying for invoice finance is generally a quick and simple process since you won’t be taking on business debt. Most factoring providers have an online application process, where you can complete a short form and upload your supporting documents.


Along with identity documents, expect to be asked for details of your customers, copies of your invoices and an ‘aging report’, which will allow the factoring company to assess the creditworthiness of your customers.


Invoice Finance - Aging Report

Alternative lenders tend to process applications very quickly, so typically a factoring facility can usually be set up within a day or two.


Once all the administration has been completed, you can usually start selling invoices right away.


When the factoring company accepts an invoice you can expect cash in your account almost immediately.

How to choose an invoice finance provider

While you’ll obviously want to consider the cost – including all the ‘hidden’ fees and charges – the reputation and conduct of a factoring company is probably the most important point to look at. After all, this company will be dealing directly with your customers, so you need to know that they won’t alienate your client base with aggressive or intimidating debt-collection tactics.


Invoice Finance - How to choose an invoice finance provider

Remember that alternative finance providers in Australia aren’t subject to the same strict regulations as the high-street banks, so you need to be sure you’re dealing with a reputable provider.


You may want to seek recommendations from other business owners or your trusted networks.


Be sure to check all the terms and conditions before you enter into an arrangement, especially if you’re opting for whole ledger agreement where you may be locked in for a considerable period of time. If flexibility is important to you, shop around to find a provider that will offer spot factoring rather than whole ledger.


That may also be the case if you’d prefer to pay extra for the peace of mind of non-recourse factoring – as this is higher risk, not all providers will be willing to offer it, especially if your customers have a history of late payment.


How to choose an invoice finance provider

Invoice factoring can be a very useful option if you need funds fast to cover a shortfall in working capital. But there are several issues you should consider first.


  1. Once you sell your invoices to a factoring company, they will contact your customers to collect payment. This will make your customers aware that you are relying on finance, which may raise concerns in their minds about your financial stability.


    Worse, you have no control over the way the factoring company treats your customers – if they behave aggressively and your customers have a bad experience, you could end up losing business and damaging your reputation.


    So it’s advisable to let your customers know how payment is collected before hand.


  2. Invoice factoring is only a short-term financing option. It doesn’t provide you with any extra cash to invest in your business – in fact, it will reduce your profits since you’ll lose the margin of the factoring fee.


    Invoice Finance - Invoice factoring is only a short-term financing option

    It is absolutely not suitable for longer-term business purposes or major investments, and if you choose to use it for short-term investments like purchasing additional stock you’ll need some other source of income to cover your regular expenses.


    It’s very important to consider your needs carefully and discuss your options with an independent professional financial advisor before entering into a factoring arrangement.


  3. Selling your invoices allows you to accelerate payment from your sales – but if you decide to stop factoring, you can be left with a very long gap in your income, which can be very difficult to manage. Be sure to plan your exit carefully, to make sure you won’t be left with a cash flow crisis.

Conclusion

Invoice finance is a great way to obtain access to finance without going into debt.


It still allows you to offer credit terms to your customers, but with the added benefit of receiving the majority of your invoiced amounts from day one, instead of 30+ days later.


It’s a popular option for businesses that wouldn’t be approved for a business loan.


You should now have a good idea on which of the different types of invoice factoring is best suited for your business needs, and how to choose a factoring company.


Is factoring a good option for your business?


Let us know why by joining in the conversation below.

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