10 Reasons Why Invoice Finance Is So Important In 2021
Small-to-Medium Enterprises (SME’s) have become increasingly prevalent in the UK, constituting 3/5th of the employment and half of the turnover within the private sector. But, unfortunately, 60% of new businesses collapse within three years, whether due to the economy or financial struggles.
Therefore, it’s crucial that a company has enough working capital to sustain its operation and remain afloat through any crisis. However, traditional finance methods such as business loans, overdrafts, and lines of credit have considerable drawbacks.
That’s why invoice finance has risen in popularity in recent years. With its simplicity and ease of utility, SMEs, as well as large companies, can get the funding they require.
Still, many people may have heard of invoice finance but have no clue about what it is, how it works, and what makes it important. In this article, we’ll lay out all the things you need to know about this subject so that you can decide whether you should try it out for your business.
Invoice Finance: An Overview
Just in case you’re unfamiliar with the concept of invoice financing, we’ll give you a quick rundown. Quite simply, invoice financing is where an invoice finance provider/lender buys your business’s unpaid invoices in return for a small sum of money, allowing you to sell your unpaid invoices.
Basically, once you agree with an invoice finance provider, they’ll provide you with up to 80-90% of the invoices you send them, usually within 24 hours. Then, when you deposit the payment you collect from your client into the account the provider specifies, you’ll receive the remaining percentage of the invoice balance minus the provider’s fee.
Types of Invoice Finance
Invoice factoring involves selling your invoices to an invoice financing service, aka “the factor”. With invoice factoring, you hand over all the administrative control of the sold invoices, meaning that the financing service will go around collecting customer payments and doing all credit control procedures until the customer pays up.
This can be both a good and a bad thing (more on that later), but the thing to focus on is that the factor will deal with your clients directly. That means your client will find out that you’ve borrowed money and might assume the worst about the stability of your business.
The saving grace in such a situation is that some factors agree to conduct their payment collections under your business name. Thankfully, this preserves your company’s image in front of the customers, leading to more future dealings with your company.
Note: Usually, invoice factoring signifies giving the ownership of your sales ledger to the factor and all the duties and authorities it comes with. Nonetheless, almost all factors finance one invoice only, giving rise to the name “spot factoring“. As such, business owners can choose which invoices to keep to themselves and which invoices to send to the provider.
Invoice discounting is practically the same thing as invoice factoring, but with one key difference. Here, the provider doesn’t assume credit control duties and leaves you to deal with payment collections yourself. That means all administrative control of your sales ledger is left in your hands, with the provider only acting as a money lender.
That being said, since the provider doesn’t provide other services than lending you money, his fees are sometimes smaller than those of an invoice factor. However, other times the fees are higher, especially in non-recourse cases.
Having said that, the main advantage of invoice discounting is that your clients never find out you borrowed money since the lenders never deal with the clients. Such confidentiality makes invoice discounting popular among various businesses as you maintain your customer’s trust.
Nevertheless, you must already have an established credit control team with effective payment collection methods in order to use invoice discounting. Also, know that most invoice discounting providers will only accept invoices dated 90 days or older, so this will limit your cash flow to some degree.
Still, some services offer you the option of raising finance against a part or all of your sales ledger with processes called selective and whole invoice discounting, respectively. So, you still have a say on which way you want to go with invoice discounting.
Why Is Invoice Finance Important?
So, what makes invoice financing important? Well, there are plenty of advantages that such a service can provide, allowing both small and large businesses to bloom and thrive. Accordingly, we’ll lay out all those advantages to make you see the importance of invoice financing.
1. Immediate Cash Flow
This is the most prominent advantage of invoice finance. Within 24-48 hours, you can get your hands on hard cash that enables you to take care of your business matters. Opposite to bank loans and other methods of borrowing money, you’ll quickly have access to cash without having to wait for assessments and approvals.
Since you don’t have to wait the usual 30-120 days until the customer fulfils their invoice payment, you’ll be able to get a headstart on your business endeavours. For instance, you can pay your bills. You’ll also be able to pay your suppliers, which allows you to benefit from their early settlement discounts and other incentives.
2. Enables Growth and Reinvestment
One more benefit of the cash boost from the tied-up cash is that you’ll be able to get newer equipment and machinery. This will allow you to increase your business’s efficiency and production. Furthermore, you’ll have an opportunity to buy additional stock/inventory.
Consequently, this will enable your business to accept more orders, and you’ll continue your sales and increase your business’s turnover. And when your turnover increases, the happier your stakeholders will be.
You may also get new investors, and accordingly, your funding will further increase, allowing your business to grow even more. Needless to say, the more your business grows, the higher the chance you’ll stay ahead of your ruthless competitors.
3. Added Security
When you have to wait weeks or even months on end for your payment, your working capital will be severely affected and stretched to its limits. Accordingly, you’ll find that growing and improving your business will become considerably tricky.
Thankfully, invoice financing takes this problem off your hands as your business won’t be impacted as much by late payments. This is especially true when invoice finance providers credit-check your clients before you deal with them.
In such cases, you’ll only deal with clients that are very likely to pay their dues at the specified time, and as a result, you won’t put yourself in the unpleasant situation of debtor insolvency.
And it’s not just security against late payments. Invoice finance also allows you to invest the money you get in your business without having to risk your personal savings, all in return for a small fee.
4. No Need to Personally Chase Invoice Payments
As previously mentioned, invoice factoring services chase your unpaid invoices for you. This allows you to focus on other business-related matters and direct all your time and energy to more important things.
Generally, chasing down the customers who haven’t paid can be a physically and mentally strenuous matter for the chaser. However, you can spare yourself the trauma if you have a finance service taking care of this issue.
They’ll be able to achieve results much faster, meaning you’ll be able to get the remaining balance of the invoice quicker than when you have to do it yourself.
5. No Debt
A tangible benefit of invoice financing is that it doesn’t incur any additional debt. That’s because all the money you’re getting from the provider is already money that you’ve earned from your dealings with clients.
When you compare it to bank loans or overdrafts, you borrow money that you still haven’t earned to grow your business. However, if your business tanks and you can’t raise the sum you borrowed in addition to the bank’s interest, you end up incurring quite a hefty debt that may take you a few good years, if not most of your life, to pay back.
Understandably, no one wants this threat hanging over their neck. That’s why in recent years, invoice financing became a greatly preferred option for business owners, be it small companies or large corporations.
6. Reasonable Fees
Fortunately, the fees of the invoice finance provider aren’t that extravagant. Ordinarily, the agreed-upon fees for a single invoice lie in the 0.5%-5% range, with no additional interest. When compared to the interest of other financing methods, this is basically nothing in the grand scheme of things.
The reasonable fees are only possible because invoice finance has yet to become a part of the services regulated by the Financial Conduct Authority (FCA) in the UK. While the FCA may increase the safety and fairness of invoice financing, it’ll also increase the service’s overall cost. Regrettably, this can be detrimental to a business, especially if it’s not making much money.
Therefore, the longer invoice financing remains unregulated, the smaller the provider fees will be, and the more the users can benefit from such a service. Accordingly, many large businesses prefer to use invoice financing, as it acts as a sort of low-rate loan that doesn’t have difficult eligibility criteria.
Still, keep in mind that generally, the bigger the value of the invoice, the larger the fee will be, and vice versa. This is because the risk to the provider is higher with larger invoices. Accordingly, the bigger charge acts as compensation for the higher risk.
7. Short Commitments
For commitment-phobes, invoice finance is a great choice. With invoice financing services, you simply remain affiliated with the service provider until the customer meets their dues. Then, each person goes their own way once the payment has been appropriately divided.
If you only need funds temporarily, invoice finance will be optimal for you. That’s because, with it, you don’t have to pay for any money you don’t instantly need nor sign a contract for an extended period of time as you would when getting a long-term loan.
8. No Assets Required
With invoice finance, you can get the money in advance even if you don’t have any assets. Normally, other financing options require the company or other personal assets to be used as collateral in case the client is unable to pay back the borrowed money.
In contrast, invoice financing requires no other collateral than the unpaid invoice. This makes it great for business owners who don’t have any substantial assets, namely companies that have just started to stand on their feet.
9. Don’t Worry About Credit Score
If you’ve been dealing with suppliers on credit terms, there will come a time when they’ll demand you pay them back. Unfortunately, that time may come before you’ve managed to acquire the required funds from the invoices.
As a result, your credit score will plummet, and the financial options available to you will diminish. This especially happens when a business goes through an expansion, where the working capital needs to be directed to other areas. However, with invoice finance, you’ll be able to preserve your credit score, as the hands-on cash will save you from falling behind.
Honestly, the credit that truly matters with invoice finance is that of your customer, not yours. To elucidate, if a customer is notorious for always being late on his payments, your service provider will direct you to steer clear of dealing with the said customer to increase the surety of the invoice payments.
10. Start-up Friendly
Invoice financing, factoring in particular, is a superb option for start-ups. That’s because it allows them to acquire considerable funding that they’d be unable to receive through other channels.
It also gives them a sales ledger management team, which many startups lack. As such, that team ensures that your credit control performance doesn’t suffer through adequate payment collection methods.
All this will decrease the business’s operating costs and, in conjunction with the cash flow, free up business owners for managing and advancing their companies. On that account, a startup can maintain its standing among its competitors until it has the time and funding necessary to develop its own credit control team and procedures.
A Few Things to Consider
As with every financing option, it’s not all rainbows and sunshine. There are certain points that you need to consider before participating in invoice finance.
For one, your profit margin will decrease since you pay your finance provider a fee for every invoice. Also, your business may end up excessively relying on this service when you could’ve simply negotiated with the customers and convinced them to make their payments on time.
Also, when you use invoice factoring, your customers may presume your company is financially struggling, and they may stop their dealing with you and persuade others to do the same.
In addition, keep in mind that most finance providers may not agree to finance more than a single invoice at a time. This may put you in a pinch when you need a large sum of money, which may eventually lead you to engage with multiple services, with fees that’ll be on the higher end.
Moreover, if your business is in a high-risk sector, your fees will be higher than those that aren’t. The justification for the higher charges is that they act as a countermeasure for the sake of the finance provider since they assume certain risks.
So, if your business is involved in healthcare, construction, or other risky endeavours, you may not be able to find a lender ready to take you on, and if you do, you probably won’t get a fair price.
Lastly, take into consideration that most of the invoices eligible for financing are commercial ones. Therefore, businesses whose clientèle is the general public will be hard-pressed to find a finance provider.
In Summation, Is Invoice Finance the Right Step for You?
Whether your company is a startup, an established company, or anything in-between, invoice finance will be an excellent option for you. As long as you have a positive balance sheet and a minimum yearly turnover rate of £50,000, you’ll be eligible for invoice financing (although the criteria may differ from one provider to another).
SMEs, in particular, will significantly benefit from this funding form, mostly because invoice finance doesn’t have numerous eligibility criteria, such as assets, good credit scores, etc.
Still, remember that if you have a small enterprise that doesn’t have a proper in-house credit control team, invoice factoring is the way to go, provided that you write your invoices for other companies and businesses, not to consumers.
Meanwhile, If you’re the owner of a large company that cares about your business’s reputation, you’ll benefit more from invoice factoring, as it’ll serve as a low-rate loan.