It’s an unfortunate fact of business that organisations of all sizes need to deal with cash-flow issues from time to time. It's a problem that can affect everyone, even highly successful, profitable businesses.
This problem is often caused by events beyond the company's control where customers have contractually agreed long settlement terms and are not due to pay invoices for as long as 120 days. Some companies are part of a larger supply and distributor chain which means that they might need to pay for goods supplied before they are paid for the goods that they distribute. This can put additional pressure on cash-flow as the business needs to deal with running and staff costs in the interim. In some instances it's simply a case that customers don’t pay their invoices on time. All of these scenarios can leave businesses exposed and at risk of failure.
In order to combat this issue there has been a number of government backed initiatives. For example, the Prompt Payment Code introduced in 2008. Administered by the Institute of Credit Management, the code provides guidance and encourages good practice amongst businesses regarding the commitment to paying invoices on time.
Invoice financing is one method that can be used to overcome this issue. This finance method can also benefit businesses seeking to balance their trading style and combat long payment terms. It can also help businesses should their clients experience difficult trading conditions, where they might default on agreed settlement terms. Business owners and managers are wise to protect against this with credit insurance. More information about credit insurance can be found here).
There are two types of invoice financing which a business can utilise:
1. Invoice Factoring
2. Invoice Discounting
Both options help you to manage your business’ cash flow, and lets your business convert the money owed by customers that has yet to be paid, into immediate cash.
What is Invoice Factoring and how does it work?
Factoring or ‘debt factoring’ usually involves an invoice financier managing your sales ledger and collecting money owed by your customers themselves. Upon the raising of the invoice, the invoice financier will buy the debt owed by the customer, making a percentage of the cost (usually around 85%) available to you upfront. The Invoice Financier will then collect the full amount directly from your customer. Once received they will make the remaining balance available to your business. The Invoice Financier will charge your business interest and fees, which will vary according to the financier you use.
What is Invoice Discounting and how does it work?
With invoice discounting, the invoice financier won’t manage your sales ledger or collect your debts as with Factoring. Instead, the financier will lend money against your unpaid invoices which is usually at an agreed percentage of the total value of debt which will result in a fee to acquire this loaned money.
As payments of the invoices are made by debtors, the money collected will go directly to the invoice financier who will then deduct what you owe. This means that more money can be borrowed on invoices from these new sales up to the percentage originally agreed.
The benefits of Invoice Financing are:
- Immediate cash injection – can provide immediate working capital to cover a cash-flow blip caused by a slow-paying customer
- Easier approval – Using invoice factoring can be especially useful for a small business with a lack of collateral for a loan, poor personal credit or limited operational activity. Typically, only concerned with the value of invoices and the creditworthiness of the customer, an invoice financier can prove to be an excellent resource, particularly for smaller businesses
The risks of Invoice Financing are:
- Can be costly – Invoice Financing can prove costly, depending on the financier used. SMEs should be careful to be clear on fee and interest terms in order to avoid any unwelcome charges
- Loss of direct control – Focusing on Invoice Factoring, the Invoice Financier will deal with the customer directly, presenting potential issues when it comes to dealing with the customer in a way which has been established by the business
- Reliance on a good customer rating - If the customer has a history of late or missed payments and as a result has a bad credit rating, then the invoice financier may be unable to approve your business for financing
By utilising Invoice Factoring and Invoice Discounting, a business can reduce the effects of slow or delayed invoice payments, reducing the likelihood of business collapse.
Business Cost Reduction Associates Limited is authorised by the Financial Conducts Authority for Secondary credit broking services. If you are interested in finding out more about Invoice Financing or any other aspect of our Finance service, please contact BCR Associates on 03330 433233.