Raising finance is simultaneously one of the most important and the hardest thing any business needs to do. Raising money either through external investment or via loans is an important part of the strategy of most businesses to allow them to buy the equipment they need to reach their goals. Invoice factoring is one of the ways that businesses can access the money they need for these investments, and it is especially useful for a new business or one with lower levels of credit.
What is invoice factoring?
Invoice factoring allows a business to sell their invoices to a factoring lender at a discount, allowing them to release these funds before the invoices have been paid. It is used by businesses that invoice their customers on longer than average terms and who may not expect payment for weeks or months. The factorable amount that can be released to the business is based on the average invoice turnover of the business each month.
How does invoice factoring work?
Invoice factoring lenders will take the value of the debts owed to the business and offer to lend a percentage of that value each month as instant cash. Usually the lender will take control of the entire debtor book, although there may be room for negotiation to limit risk and avoid exposure to one large customer.
In most cases the invoice factoring lender will set up a bank account that they control. The customers of the business then pay their invoices directly into this bank account, allowing the lender to have control over how the invoices are paid, ensuring they get their money back. This differs from invoice finance which allows the business to keep control over their creditors.
When it comes to payment, there are two options for the business. A non-recourse loan (sometimes called bad debt protection) where the lender takes all the risk and must chase the invoices themselves. If any customer fails to pay, they accept the liability. For a recourse loan, the business remains responsible for any failure of the invoice to be paid. The type of lending chosen will influence the cost.
The cost of invoice factoring
Invoice factoring is a very different type of loan to standard loan structures. In most loan scenarios a lender will calculate a monthly repayment scheme that must be adhered to, or the collateral will be lost. With invoice factoring, the monthly fees (not repayments) are based on the value of the facility that has been used and how much effort the lender must expend to achieve payment on the invoices they have purchased.
As mentioned above, the invoices are bought by the lender at a discounted rate. This means they pay less for the invoices than they are worth, and they make their money by getting the entire value back from the customer. The discount rate that they will use will depend on how much of the invoice turnover the business plans on using each month, the credit worthiness of the customers and the complexity of the deal. Debtor books with lots of invoices will generally be harder to monitor and therefore may make the loan more expensive.
The lender will also charge a service fee to cover the cost of looking after the credit control and admin. Those companies the highest factorable turnover will be charged the lowest fees as the risk is seen to be lower. The total cost to the business is the service fee plus the discount rate.
If the value of invoices payable through the facility increases, the business may be able to renegotiate to a lower service charge and it can also be reviewed if the amount of bad debt decreased. These deals should be reviewed regularly to ensure the business is still getting value for money.
Finding the cheapest invoice factoring
The best way to find the cheapest invoice factoring lender is to use a calculator or comparison service. These will calculate the service fee and discount rate that each lender will charge based on the circumstances of the business and the debtor book. Factors such as the number of invoices each month, the value of the invoices, the credit of the customers and the credit of the business will all be considered. Invoice factoring is an innovative way to get guaranteed regular payments to your business without having to worry about if your customers will pay on time. It allows a business the flexibility to invest in the future knowing what the invoice income and the costs to the business will be. Finding the cheapest possible fees and discount rates are the first step to keeping these costs to a minimum.
Get in touch with us at Funding Bay for your invoice financing needs.
Check out our invoice finance calculator here.
