Invoice based lending
Finance & Funding
Key learnings
- Invoice financing can help you manage your cashflow and move forward with investment decisions.
- You should only use invoice finance if you know you have revenue coming in to pay for it.
- If some of your customers are large corporates, they may have longer payment terms.
If you’re running a successful business but need quick access to capital to improve cashflow or reinvest elsewhere, invoice financing could be for you. Invoice based lending is a way for businesses to borrow money against the amounts due from customers. It can be a useful bridge between completing work and receiving payment, enabling businesses to pay employees and suppliers, reinvest in operations and boost growth earlier than they could have otherwise. Here, we look at the main aspects of invoice financing, when you should and shouldn’t use it, and the associated risks.
Invoice based lending can be very beneficial for businesses, but there are things to remember before deciding if it’s right for you.
While invoice finance is designed to combat cash flow issues, it is not a replacement for revenue.
Loans and overdrafts can give you a cash injection when business is slow, invoice finance is predicated on your business successfully winning sales and raising invoices.
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Types of invoice financing
There are two types of invoice financing:
1. Factoring:
This usually involves an invoice financier managing the sales ledger of your business and collecting money owed by customers themselves. This means customers will know you’re using invoice finance.
Process: You sell the invoice to the invoice finance company (financier). The financier then pays an agreed percentage of the invoice upfront (eg 85%). Once the financier collects the full payment from the customer, you are then paid the remaining sum (eg 15%).
*Note: Discount charges (interest) and fees would apply for these services.
2. Invoice discounting
The invoice finance company lends you money against your unpaid invoices - this is usually an agreed percentage of their total value. Fees will apply.
Process: As customers pay the invoices, the money goes to the financier. This reduces the amount you owe the financier so you can borrow more money on invoices from new sales up to a percentage you originally agreed. You’re still responsible for collecting debts if you use invoice discounting, but it can be arranged confidentially so your customers won’t find out.
*Note: Fees apply for these services.
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What are the risks?
Taking out invoice finance has the potential to affect your credit report because invoice finance providers conduct credit checks when you apply for finance.
You are also dependent on your customers paying what they owe, and invoice finance providers may hold you accountable if they don’t.
Invoice finance providers can make changes to the fees you pay, depending on the service you require.
Providers usually take a charge over book debts which usually prevents a company from obtaining overdraft facilities.
If there is a seasonality aspect to your business, you may also be unable to access funds if your revenues drop significantly.
In addition, your revenues are dependent on a few customers, the finance provider might restrict the amount they release against invoices to reflect this additional risk.
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Is invoice financing right for you?
If you work with big customers that insist on longer payment terms (eg 90 days versus 30 days), but they provide business that is too valuable to turn away, invoice financing could help you maintain relationships with these customers without having to sacrifice your cash flow.
Next steps...
- Decide what your short and long-term capital requirements are going to be before deciding on a particular funding solution.
- Identify which customers you think are going to have longer payments terms and whether you will have enough business coming through the door to justify invoice finance.
- Identify the fees, terms and conditions attached to an invoice financing agreement before entering one.