Is Invoice Financing or Factoring the Answer to All of My Business Problems?

In a nutshell, the answer is likely to be no, not to all of them!

However, they can be for many financial issues. For many businesses these methods of financing can save a lot of stress over cash flow by getting money into your bank account quickly.

Most people would expect that a rapidly expanding business would have healthy finances, but the reality is often the opposite.

This is because spending money on new ventures while waiting for customers to pay their invoices leaves the bank balance at an all-time low, despite profit levels rocketing.

It’s a common issue for small businesses, particularly those that issue 30-day invoices that often become extended to 60 days or longer.

Find out more about Invoice Finance and how it can help your business

How does invoice financing work?

Growing businesses can be struck by cash flow problems

Companies that are faced with growth can easily let cash flow fall under the radar in exciting times. As the business grows, more cash becomes tied up in working capital; the knock-on of this is of course going to be problems with cash flow.

Cash from previous sales need to stay there as long as possible – where you are going to find the money to pay for future supplies?

If your business is new, ordinarily, you can’t get credit from suppliers without paying extortionate fees; this is the reason for the problem being so common.

There are a number of options available to you if you are in a similar situation, however.

Of course, you could take out an overdraft or loan to create working capital. It takes a long while to arrange and secure a loan however, and often, they will ask for the amount to be personally guaranteed so that you will become liable for the amount personally if it remains unpaid. If the business needs cash without delay, this may not be an option.

Invoice financing (also called factoring) is another option, which effectively borrows the money against the invoices you have raised to your customers.

Find out more about Invoice finance and how it can help your business

How invoice finance works in real terms

In practice, you will send a copy of all invoices issued to a finance company, and it will then ‘lend’ you 80-90% of the amount; you will receive a lump sum as soon as the invoices have been issued, without having to wait and chase your customers for payment.

This means that you are able to re-invest the amount into your business immediately, as working capital, a way to fuel further growth or just keep your cash flow in the green.

You will receive further payment when your customers have paid up, minus the company’s fees and interest on the amount ‘borrowed’.

As an example, when you send a factoring company an invoice you have raised for £3,500, they may pay you 80% of the value immediately, so in this case £2,800.

In 30 days, your customer will be chased for the amount by the factoring company, and once the sum has been paid in full, you will receive the remaining £700 minus fees and interest.

Invoice finance has been around for a very long time, but it is not suitable for every business; read further to understand the main benefits and drawbacks of factoring with small businesses in mind.

The pros and cons of invoice finance

Invoice finance pros:

• Positive cash flow

Invoice finance is our most recommended method of keeping your cash flow above the surface if working capital is swallowed up quickly. This is of course behind ensuring that your customers pay in advance, but this method is not easily achievable! The bank account balance will rise much more quickly using this method, so your business is less likely to run out of cash while it grows.

• Cash will be injected fast

In our experience, a large debtors book is one of the least reliable assets a company can have on its’ books. A high percentage of these can be paid immediately using factoring company.

• Plan ahead

Knowing when a cash injection is going to hit does wonders for a growing company; calculated financial risks are so much more reliable than agreeing to things when you are not sure the cash flow is going to be there. Investors may also be easier to attract when borrowing capital as regular cash flow can be proven.

• Customer knowledge

Many factoring companies insist on credit checking your customers before you offer them credit. This reduces risk for everyone; there’s no point selling something to a customer who doesn’t have the means to pay.

• Invoice finance is a competitive industry

This means that prices are kept low as competitors often use this as their selling point.

• Professionalism

Another benefit is that factoring companies will send invoices and payment reminders in an extremely professional manner – certain customers will respect a larger company name (particularly if you use factoring services offered by a big name bank, for example). This often means that they will therefore be less likely to avoid paying up on time.

• Bad debts can be avoided

‘Non-recourse factoring’ leaves you with no liability if the debt ‘turns bad’ (in other words, the customer doesn’t pay up). Of course, this path is more expensive than ‘recourse factoring’, as there is more risk to the company if they are taking on your debtors book fully.

Invoice finance cons:

• There is a cost

Obviously, using factoring companies is still a form of borrowing an amount of money, and there will always be an associated cost to this. Every invoice factored will be paid for, along with interest on the amount of money you have actually borrowed. In simple terms, customers who take a long time to pay will still come at a higher cost to others.

• Possible loss of control

In some cases, factoring companies will demand to have a say in how you conduct your business, as far as risks are concerned and the customers you take on. For example, you may find that a factoring company will not accept invoices for new customers while other customers haven’t yet paid up, even if you are happy to take the risk. It is possible that your terms & conditions will need to be updated and your customers will need to be told of the factoring company’s way of doing things.

• You may still be liable

‘Recourse factoring’ is cheaper, but it denotes that the debt owed is still yours – so in these cases, when customers don’t pay, you will still lose money. When this happens, factoring companies usually ask for their advance back after a certain amount of time, and they may of course take money from future advances. For this reason, cash flow reserves will still be very important!

• It can become an addiction

This may sound extreme, but using factoring companies can become similar to drug taking. Once the business is relying on factoring for good cash flow, it is likely to need a decent injection of cash flow to wean you off it.

Next steps

Making sure you’re getting the right type of finance for your situation can be a minefield, we can help explain which would be the best option for you. Find out more on our invoice finance site www.forbesburtonfinancial.co.uk