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A Guide to Invoice Financing for Small Businesses

Whether financing an expansion or covering a short-term cash flow crisis, invoice financing can be a useful way to access capital.

Getting paid on time and guarding against the risk of cash flow problems have long been two of the biggest problems facing businesses. With finances often operating on fine margins, and access to conventional credit in short supply, alternatives such as invoice financing can be a good way to unlock capital tied up in delayed invoices. However, as with any loan product, it pays to understand the implications.

What is invoice financing?

Delayed payments are one of the biggest reasons why small businesses fail. Despite attempts to improve the situation, many companies are still waiting, 30, 60, 90 or even more days before being paid. That gap leaves them vulnerable to cashflow problems which, in extreme cases, could threaten their survival. According to the Federation of Small Businesses (FSB), around 50,000 business go bust every year because of late paying clients. The FSB estimates late payers cost the UK economy £2.5bn. 

For small businesses, cash is king, and if that runs out, even an otherwise profitable business can face the end of the road. In some cases, then, invoice financing can be a real-life saver.

It can come in several different forms, but the premise is simple. As a business you will sell your unpaid invoices to a company which will take them on. They may then take ownership of the invoices and take responsibility for chasing them up or you may pay them the balance of the invoice when it is finally settled.

This represents an attractive option for many small businesses. First, in a world in which getting conventional loans can be tough at the best of times, loan providers will be less concerned about your credit history and bank balance than that of your customers. It is they, after all, who will be paying back the money.

For a company which might have a limited or poor credit history, therefore, this can be an accessible form of credit which helps it solve problems caused by long payment terms or unreliable payers.

Types of invoice financing

There are several different types of financing available.

  • Invoice factoring: The most common type of invoice financing sees you sell your invoice to the factoring company. They will give you an upfront fee and will chase up the payments. Once the company has paid up, the factoring company deducts the borrowed amount plus the fees and returns any outstanding money to you. In addition to freeing up capital and easing cashflow, it can save you the time and expense involved with chasing up the invoice yourself. On the downside, your customers will know you’re using a factoring company which can affect your image.
  • Invoice discounting: If you’d rather keep your relationship with an invoice financing company secret, you can choose invoice discounting. You’ll receive a lump sum for some or all of your invoice as before, but you will retain responsibility for chasing the invoice up. Once paid, you will repay the borrowed amount plus any fees.
  • Selective invoice financing: Many financing arrangements require you to sign over all of your invoices to the financing process. However, if you’re a company which only occasionally experiences cash flow problems, you can choose a more flexible, selective process. This time, you’ll only hand over those invoices you specifically want financing for. In many cases, companies may sign over their largest invoices which also represented their biggest liability while retaining control over smaller sums which tend to be paid more quickly.
  • Online auctions: A slightly rarer option is to sell your invoices via an online auction. You can choose which invoices you’d like financed, upload them to a site and open them up to bidders. The winner will take control of the invoice and have responsibility for chasing it up.

Within these options, you may choose between recourse and non-resource financing. With the former, you retain liability for any bad payments. If your customer defaults, you’ll have to pay all the money plus the fees back to the company. With non-resource financing, they take on the liability. Each option will vary in cost and ease of access.  

Pros and cons

The benefits of invoice financing can be pretty obvious, it gives you instant access to funds which might otherwise take months to be processed and reduces the risk of cashflow problems. Financing can be easier to access, and you will save time and money by handing over the process to another company.

On the downside, you will surrender part of the invoice to the financing provider. Because of the lower barrier to entry the costs can be quite high, and it can create liabilities especially if you chosen recourse financing in which you retain the risks. Although they are usually more accessible than other types of lending, this will depend on the credit history of your customer. So, if their history is bad you may struggle to access financing.

When you make a decision, therefore, you should carefully weigh all the options, assess your financial position and make sure you understand the full implications of any decision you make. 

Get in touch with one of our specialists at Funding Bay to chat about how Invoice Finance can help your business.

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