Small to medium-sized companies heavily rely on the ability to build up sufficient and sustainable cash flow. A regular source of available cash allows these companies to invest in the staff resources, inventory and capital equipment required to grow the business.
However, having access to a regular flow of cash also presents them with their biggest challenges. Companies have to navigate different market conditions, which include slow periods or times when there’s rapid growth, and they need to be able to meet the demand. Also, customer can be slow, late or non-payers, which puts a severe dent in the health of their accounts receivables and thus their access to cash.
Invoice finance provides a smooth, flexible and cost-effective way to access the funds that are tied up in invoices until they are paid. We answer the following questions to give you a good understanding of the ins and outs of invoice financing.
What is invoice finance?
Invoice finance is the prepayment of most of the invoice value owed to you by customers. The finance company extends the funds immediately after you have presented the invoice to the customer and, in most instances, well before they have made payment.
Customers, particularly large companies, often demand payment terms of anything from 30 days to 90 days, which is a long time in the business life of a small- to medium-sized company.
The invoice finance company lends you anywhere from 75% to 95% of the value of the invoice. The remaining 5% is held back until payment is made by the customer and then you will receive the balance, less the fees you have negotiated with the finance company.
Why use it?
Getting immediate access to the funds gives you peace of mind that you will provide you with predictable cash flows. With a healthy debtor’s book and no funds outstanding, you know you will be able to cover your monthly expenses. You won’t have to rely on more expensive funding sources, like credit cards and bank overdrafts, and go through the administratively intensive and time-consuming process of applying for conventional bank loans.
Once you have negotiated the contract with the invoice company, the funds owing to you by customers will become available within a matter of days rather than a week or so it takes to apply and get approval for a bank loan.
What types of invoice finance are there?
Invoice finance companies offer two services: invoice discounting and invoice factoring.
The former allows you to pick and choose the invoices you want to hand over to the finance company for funding. It is called invoice discounting because you receive the discounted amount and remainder when the customer makes the payment.
The latter, invoice factoring, is a more comprehensive financing arrangement, in which you contract with the invoice finance company to handle your entire debtor’s book. The finance company will issue the invoices to customers, pay you the discounted value of your invoices and follow up on payment until it is secured.
Why use invoice discounting?
You remain in control of the invoicing process, and thus you maintain the relationship with the customer. You can also only finance those invoices that either has extended payment terms when you need the cash sooner or have a history of late payment.
Why use invoice factoring?
Invoice factoring enables you to hand over the administratively onerous process of issuing invoices, following up on them and securing payment when you could be devoting that time to more important activities that facilitate the growth of your business. However, since customers will be directly interacting with the invoice finance company and not you or your staff members, you will need to secure the services of a finance company that you are confident will represent your company efficiently and professionally.
You can opt for a confidential invoice factoring service. This finance option allows you to maintain your relationship with your client. That leaves the invoice finance company responsible for the funding of all your invoices.
What do you need to consider when contracting with an invoice company?
It is essential to shop around for an invoice finance company that has the experience and proven skills. Given the increased demand for invoice financing, the number of companies providing invoice financing has proliferated.
You will be entering into an ongoing relationship with the financing company. Thus, it is worth doing the upfront homework to ensure there is a good fit between the invoice financier and your company.