Both models of financing offer businesses funds based on outstanding invoice values but factoring is far less flexible than conventional financing.
A consistent cash flow is the lifeblood of a business. It is how an organisation is able to purchase stock, hire and train staff, diversify and ultimately expand its practises. But what happens when this lifeline is interrupted?
It is a question and a challenge that many businesses face. Limited or unreliable cash flows can paralyse a business, stalling growth and forcing an operation into debt or even closure. With the economic climate being what it is, businesses simply cannot afford to allow operations to slow. One of the biggest reasons this can happen, is due to outstanding invoices.
A 2015 study commissioned by PayPal and Intuit Australia found that, on average, small businesses in Australia are collectively owed $26 billion dollars at any one time and spend an average of 2½ working weeks each year just chasing payments (Galaxy Research Study, September 2015). With this amount hanging over the heads of businesses consistently, more than a quarter of business operations surveyed confirmed that they have taken out a loan to cover their own expenses.
Finding a way with
This process is called invoice financing, a general term used to describe asset based lending which occurs whenever a third party agrees to buy a company’s unpaid invoices for a fee. It is a way for businesses to borrow money based on amounts due from customers and can solve many of the problems associated with delayed invoice payment without the hassle associated with obtaining other kinds of business loans.
Invoice financing is a speedy way for business to get an injection of capital into their company, allowing them to invest in the things that matter and grow their business. In invoice financing, the sum of the invoice acts as collateral for the credit sought therefore making it a more secure loan than extending a line of credit.
Invoice financing can be structured in a number of ways, most commonly by factoring.
The X Factor
Invoice factoring is a style of invoice financing whereby a company sells its invoices to a third party in order to improve their working capital. This allows for funds to be made available to the business which can be used to settle any outstanding company expenses including salaries and stock orders.
While not as rigid as more traditional financing, a vital requirement qualifying for invoice factoring is to have outstanding invoices from approved, ‘creditworthy’ clients. If this is the case, the third party (or factor), may pay the business between 60% and 85% of the total worth of the invoices upfront, making it an option for small businesses that don’t have the required assets to apply for conventional financing.
Assuming full payment of the invoice is made, the remaining 15% to 40% of the total payment is usually passed along to the business, along with any fees accrued during the process.
The factor however, can apply what is known as “concentration risk” or “exposure limits” and thus the amount advanced can vary from debtor to debtor. It is vital when looking at these forms of finance to understand, in absolute terms, the smallest nuance, as the effect can be significant, particularly when contracts are involved.
The way forward
While both models of financing offer businesses access funds based on outstanding invoice values, factoring is far less flexible than conventional financing. As it involves outsourcing all credit control processes to the factor, many businesses are (non-too-surprisingly) reluctant to go down this path as it means relinquishing control of day-to-day operations. There are also usually longer term contacts associated with factoring, with higher fees being passed onto the business as a result.
It is for this and many other reasons that invoice financing is a better and more accommodating solution for businesses. Invoice financing only assesses the invoices that the business owner wants to sell, rather than the whole outstanding sum, meaning that the business remains in charge of their accounts, and their business.