What Is Invoice Financing?
Although invoice finance provides immediate cash for your
overdue invoices, it has disadvantages.
Businesses can borrow money by using outstanding invoices as collateral through invoice finance. You can obtain cash from your accounts receivable before your clients pay their invoices via invoice financing, also known as accounts receivable finance.
Although invoice finance can give you quicker access to
money, it also has drawbacks. Continue reading to learn how invoice finance
functions and whether it is a wise choice for companies that require capital.
How Does Invoice Financing Work?
The phrase "invoice finance" refers to services that lessen the financial strain of waiting for clients to pay their bills. Companies can utilise invoice financing to reduce the time it takes to turn their inventory investments into cash or to reduce the cash conversion cycle.
According to Ben Johnston, chief operating officer of
small-business financing firm Kapitus, "many business owners obtain
invoice financing, which advances cash against outstanding accounts receivable,
in order to secure the cash necessary to start the next project while waiting
for payment on the last." This is a key component of many business owners'
growth strategies since it enables them to accept many more contracts than they
otherwise could afford.
Invoice Discounting vs. Invoice Factoring
Factoring and discounting of invoices are two types of
invoice finance. The person who obtains money from the client is the primary
distinction between invoice factoring and invoice discounting.
Invoice Factoring
With invoice factoring, your business gives a lender a discount on the control of your accounts receivable in exchange for fast cash. Depending on the value of your bills, you can get 70% to 90% up front and the remaining amount, less a fee, after consumers pay their outstanding amounts.
The drawback of invoice factoring, aside from the cost, is
that your clients must make direct payments to the lender. Your consumers are
aware that you are financing their debts, and you no longer have control over
the collection process.
Invoice Discounting
According to Dan Karas, chief credit officer of capital
finance at C2FO, with invoice discounting, the lender normally lends your
company 80% to 90% of the invoice amount. When your customer pays the invoice,
you will pay back the loan and keep the remaining amount, less the service fee.
How Much Does Invoice Financing Cost?
Finance costs will vary depending on elements including your customers' creditworthiness, the terms of your invoice finance agreement, and market conditions.
According to Johnston, invoice financing has become more expensive for all organisations since interest rates have increased over the course of the year.
The price of invoice financing may vary depending on the size of your business.
According to Johnston, "established businesses with sizable, creditworthy clientele may frequently secure invoice financing from banks at reasonably cheap rates." Smaller, less well-known businesses with riskier debtors will probably pay higher interest rates for capital from nonbank lenders.
With or without recourse, invoice factoring may be available to you. Because the risk to the lender is larger, factoring without recourse frequently carries higher fees.
According to Karas, "Recourse is the procedure where
the business and the invoice finance company agree on the period of time the
buyer will own the invoice before it 'charges back' the business. The terms
vary depending on the client's business model, but they are normally 90 to 120
days from the date of the invoice.
For the purpose of estimating the prospective cost of
invoice financing, several lenders provide online calculators.
What Are the Pros and Cons of Invoice Financing?
Although invoice finance would suggest that a company is in
dire need of money, that is not necessarily the case. Depending on your
situation, there are both advantages and disadvantages, such as the following.
Pros
Can fill funding gaps.
When they have to wait 30 to 90 days to get paid for their
final products and services, growing enterprises sometimes struggle to afford
the upfront manufacturing expenditures, according to Johnston. Finance for
invoices may be able to close this gap. According to Karas, it is perfect for
sectors like transportation and temporary staffing, which frequently have to
wait 30, 60, or even 90 days to collect invoices from clients but may need to
pay employees on a weekly basis.
Can be easier to access.
According to Karas, invoice financing also enables companies
that don't qualify for conventional borrowing to more effectively manage their
working capital requirements. High debtor concentration businesses, which have
a less diverse customer base, could be too risky for standard bank loans.
However, organisations that finance invoices are concerned with things like
your customers' creditworthiness.
It's probable that in 2023, accessibility will play a bigger
role. Invoice financing "will become a feasible alternative to traditional
bank borrowing in 2023, should economic conditions deteriorate as some experts
anticipate," adds Karas. This is because banks would scrutinise borrowers'
applications for loans more closely. Invoice finance "provides operating
capital in challenging times by focusing on invoice performance, such as
collectability and turnover."
Cons
Could harm your brand.
Depending on the financing option you select, you can lose
control over your invoicing and the client experience. Customers might not be
pleased that you sold their invoices to a third party, and bad collection
techniques could damage your brand's reputation.
Can be risky.
There is no assurance that clients will pay invoices in full
or on schedule. You can still be obligated to reimburse the money if they don't
pay.
Where Can You Get Invoice Financing?
Finance for invoices is offered by several businesses. American Receivable, Rapid Finance, and altLINE, a unit of The Southern Bank Co., are a few of these.
Before choosing, make sure to weigh your options and compare prices.