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Invoice financing can help optimise your business cash flow and achieve growth goals, but what is it and how does it work?
Invoice finance is when a financier advances funds based on the value of your business’s invoices. Instead of financing your supply inputs, staff wages, overheads, and business expansion with high-interest non-bank loans, invoice finance allows your business to release the finances tied up in your unpaid invoices in order to cover your costs and for investment in further growth.
You can unlock the funds tied up in your accounts receivables, by getting the money upfront, and meeting your funding needs right away – instead of waiting 30, 60, or 90+ days for your invoices to be paid, by your customers.
In exchange, the financier charges you a small discount fee based on the value of your invoice/s, when your customers/debtors pay. This fee usually ranges between 1.5% and 5% depending on the size and value of your business, the debtors you have and the volume of funding you estimate you require each month. You don’t need to give external collateral or property security, because the loan is secured by the underlying invoice.
You can choose between two types of invoice finance for your business. The first is Invoice Factoring, also sometimes referred to as accounts receivable factoring.
Invoice factoring is used for full ledger facilities. This means the funds are advanced against the entire receivables of your business as opposed to selecting individual invoices. In other words, you sell your accounts receivables ledger to a third-party finance company, who in return would typically advance up to 80% of the invoice values within 24 hours of verification and the outstanding balance (the residual amount) minus the discount fee is then received/paid to you when your debtor/customer pays in 30 to 90+ days time.
With Factoring, the third-party finance company is in charge of managing your receivables. This means you give responsibility for credit control, collecting all the debts when they fall due, and chasing customers for payment to them. For a lot of businesses, this is a very good solution as it means the owner can focus on sales and operations whilst leaving the collections to the finance company, without having to worry about employing an accounts person to chase up on payments all the time. For others it might not be an ideal arrangement as they’d prefer to manage their own accounts receivables and maintain direct relationships with customers in this way, for those that this solution doesn’t work for, then Invoice Finance or Invoice Discounting is the way to go.
On the other hand, if you opt for Invoice Finance, which is also known as invoice discounting; debtor finance; or accounts receivable financing; you have two options.
One: – like factoring this is for businesses that usually have four or more clients/debtors and are wanting to finance all invoices, being a full ledger facility. So in the same way as factoring, funds are advanced against the entire receivables of your business. The Invoice Finance company would typically advance 80-90% of the invoice values within 24 hours of verification and the outstanding balance (the residual amount) minus the discount fee is then received/paid to you when your debtor/customer pays in 30 to 90+ days time.
The second option is called Selective Invoice Finance. With this funding solution you get to choose specific invoices to send to the finance company for funding. Typically, you’ll receive the stated percentage of the invoice within 24 hours of verification. This includes checking your customer/debtor’s creditworthiness.
Unlike factoring, with Invoice Finance, be it Full Ledger or Selective, the finance company is not in charge of managing your receivables, credit control, collecting all the debts when they fall due, nor chasing customers for payment. All of this is managed by you and your accounts team, so your business retains complete control over its debtors’ ledger. So you are responsible for collecting payment from customers as usual and for your accounting and payment reconciliation.
Businesses need cash for day-to-day operations and growth, but customers don’t always pay quickly. Your business could be waiting 30, 60, or even 90+ days to get paid. Invoice Finance offers an ideal solution because it lets you sell, in a sense, your invoices. As soon as you’ve issued an invoice to a customer, you can ‘sell’ that unpaid invoice to a third-party finance company, and get upfront funding. Unlike a business loan, there are no ongoing principal and interest repayments as you are not borrowing money, you are simply getting your money upfront instead of waiting, and for this you are giving a small discount on the invoice value – think of it as an early settlement discount.
You’ll get up to 90% of the value of the invoice within 24 hours of invoice verification, without the delay of having to apply for a loan or needing to offer up assets for security. The rest will be paid to you when your customer/debtor pays the invoice (less the small discount fee charged). So you can use invoice finance like a flexible cash advance or revolving facility, which grows as you invoice more, secured by your invoices. You can use it to maintain a positive cash flow position or for continued investment in the business.
You can use invoice finance to meet the ongoing costs of operating your business. These include daily operational expenses as well as capital investments to fund expansion and growth. Employee wages, for example, constitute a major ongoing cost. By leveraging your unpaid invoices, you can pay your employees and suppliers on time without worrying about cash flow – and so be able to fulfil bigger orders to expand your business.
You might have limited personal or business assets to secure a bank loan at reasonable rates. Invoice financing means you can tap into an unused resource sitting on your balance sheet – your unpaid invoices – and receive cash almost immediately. Additionally, you can direct these funds to drive business growth. Given this, invoice finance offers a potentially cheaper, easier, faster, and safer alternative to business loans, non-bank loans, overdrafts, or equity finance.
Since invoice finance works like a revolving facility based on your recent invoices, it’s an ideal way to fund growth in a sustainable way. This is because you’re essentially using your own cash (through your unpaid invoices) and the amount of financing is directly tied to the size of your invoices. The bigger your invoices, the more funds you can access, with no high-interest payments or restrictive repayment conditions.
If your business is constrained by cash flow issues, due to growth or unexpected costs, invoice financing can complement traditional financing options. If your traditional financing options have been limited, reduced or non-existent, invoice finance offers you an excellent alternative. You can drastically shorten the payment cycle and get financing to grow your business right away.
You can fulfil orders and commit yourself to new sales and business contracts without worrying about being unable to pay suppliers and personnel. It can also enable your business to ride out seasonal fluctuations in the market (because you only use/access what you need when you need it), minimising cash flow issues when demand slows. Improved cash-flow lets you focus on your core business activities and expansion, instead of worrying about how you’re going to pay the next bill.
Since invoice finance is directly based on your sales, your financing is scaled to your business operations, making it sustainable, stable, and secure. You won’t be locked into long and onerous repayment terms and conditions. Also, you won’t need to put up personal assets to secure finance like many small business owners find they need to with the banks. Your business won’t need to satisfy other lending criteria like an established trading history, profitability, or personal net worth.
Essential business purchases like inventory, raw materials, IT and other day to day operational items, can be critical for maintaining and expanding your capacity and for growing your business. You can shorten payment cycles and get the working capital your business needs. You could have the cash in your account as quickly as 48 hours within issuing your invoice.
Having the cash for business purchases empowers you to take advantage of new market opportunities and enjoy an edge over your competitors. This might be when traditional lenders like banks are unwilling to provide financing. Finally, since invoice finance is off the balance sheet, it won’t impact your ability to access traditional financing as well.
Getting a little more insight into the benefits and potential limitations of invoice finance can help you make an informed decision about whether it’s right for your business.
One of the top pros of invoice finance is there’s no lengthy loan-approval process. You’ll still need to apply, but it’s easy to set up and the process tends to be much faster and more flexible, with less paperwork. Your business won’t need to commit to a long-term relationship, repayments, high-interest rates, or potential penalty fees. Your provider might have an automated process where you can upload invoices and have them verified and the funds in your account within a few days.
Invoice finance lets your business take on bigger contracts by shortening the collection time, the timeframe to getting paid. You can access the working capital you need to continue delivering goods and services without supply-chain constraints. This lets you concentrate your resources on growth and converting new customers. As a result, you could end up with a stronger cash-flow position to offer loyal customers credit lines and longer payment terms, for example.
Invoice finance gives you extra control because you may be able to choose the invoices you want to fund. This means you’ll be able to control the number of funds you access through your invoice finance arrangement. You can scale up the financing with your sales without having to reapply or re-negotiate. Invoice finance is typically much cheaper than high-interest unsecured loans and business overdrafts. You’re unlocking funds without going into debt or putting your assets at risk.
Improved cash-flow health, no added risks of assets used as collateral, and no negative impact on your relationships with customers are some of the other benefits. In fact, most large businesses today look upon their smaller clients (ie your business) positively when they know an invoice finance solution is in place, as they know you are growing and have the funds to do so – less risk on them, in you defaulting on delivery of your product. Your trading history, net worth, and profitability won’t be barriers to securing invoice finance because your invoices are used as security. Finally, if your debtor defaults, you could be fully protected through the invoice-finance company’s trade credit insurance policy.
One potential challenge of invoice finance is your financing will be limited to the value of your invoices. Depending on the financing company, you might need to cover the cost of non-payment by your debtors. Invoice finance is only offered on commercial invoices only, so if you’re a B2C business, your consumer invoices will not be eligible.
You don’t receive 100% of your invoices, so if your profit margins are already very narrow, the discount fee charged by the invoice-finance company will take away some of your gross margins. If you don’t work with a reputable company, you could end up paying more than expected in additional fees. While invoice finance can support your business in numerous ways, it’s not a cure-all for low profitability and rising expenses.
Given all the benefits of invoice finance, what sort of businesses can derive the most benefit from invoice finance?
Invoice-finance providers might have basic eligibility criteria like having an Australian Business Number or supplying services or goods to other businesses on trade terms rather than cash on delivery. You might need a certain minimum annual revenue – this is usually at least $1.0 million per annum and at least a certain number of customers to be eligible. Invoice financing is particularly suitable for small and medium enterprises (SMEs), especially those that maintain their own in-house accounts-receivables team.
Invoice finance suits any sort of business that is invoicing other businesses (ie: B2B) on credit. Such industries include Wholesale Trade; Manufacturing; Logistics; Mining Services; Labour Hire; and Business/Professional Services, to name just a few.
While invoice finance is complementary to bank financing since it has no impact on your credit score, it’s also a great alternative. For SMEs finding it hard to secure traditional financing or extend their overdrafts and lines of credit, invoice finance could be the right solution. If your business has slow-paying clients, you can use invoice finance to manage potentially serious cash-flow issues.
SMEs that work with commercial clients who have good commercial credit are great candidates for invoice finance. Businesses that are seeking to shorten payment cycles or need funds to pay expenses and fund expansion should also consider invoice finance.
Businesses might use invoice finance for a wide variety of reasons. SMEs can be particularly vulnerable to cash flow constraints and seasonal fluctuations. Invoice finance boosts cash flow and dramatically shortens the time to pay for invoices. It unlocks funds for overheads and for reinvestment back into the business. This supports improved operations outcomes and it can set the stage for sustainable expansion.
Additionally, the better liquidity and speed afforded by invoice finance can give businesses a competitive advantage. For example, your business can accept new business contracts without worrying about how you’ll finance new inputs costs or raw materials and stock or how you gonna pay staff and contractors. Also, the approval process can be much shorter than the process for traditional commercial debt facilities.
Moreover, invoice finance offers a lower risk for businesses because you don’t need to use personal or property for collateral. You can get quick access to funds whilst enjoying the flexibility to grow access higher or lower finance limits based on your sales and receivables value. You’re not limited to your overdraft limit or the value of your property security. Rather than depending on your profitability and trading history, invoice finance is based on your current position – on your sales and revenue.
Once you’ve decided invoice finance is right for your business, you’ll be looking for the right provider. Consider the following insights and strategies when reviewing prospective providers. Keep in mind the company you choose will be like a business partner, one who assists you with optimising cash flow and working capital. One that will work with you on a daily, weekly and monthly basis, each time you sell a product or service and invoice your customers.
Consider what type of finance you’re looking for. Are you looking for a Factoring solution where you hand over your entire accounts receivable ledger to the finance company or are you looking for more flexible arrangements that allows you to select individual invoices for discounting or still provide your entire accounts receivables ledger, but retain control of your collections? The latter will allow you to save on costs as this is traditionally the most cost effective funding, however each do have their merits and each option needs to be duly considered in light of what will work best for the business and its customers.
Make sure the provider caters to businesses like yours in terms of size, revenue, location, and sector. Ask the provider about the flexibility of their service. If you can scale up and down invoice values as your business needs, you can avoid paying more in discount fees than you need to.
Check with the provider about their fees – all of them. Are there any hidden or extra fees with this provider? Is their pricing competitive? Are they happy to deal with the invoice amounts and volumes you have in mind? Is the provider committed to professionalism?
Ask the provider about how they deal with invoices that go unpaid. Does the financier offer appropriate insurance, like trade credit insurance, as part of their funding solution? Consider ease of use, visibility and customer service. Ideally, you’ll have easy access, such as through a user-friendly online portal with self-management features giving you real time access to your account to see exactly what funding availability you have at any given point in time. Look for fast approval, check payment times, and review their discount and advance rates.
Do due diligence, like considering how long they’ve been in business and how much experience they have. Check out whether they specialise in certain industries and whether they have positive reviews and customer testimonials online.
Finally, don’t forget to ask the financier how they’re financed. Check they’re not likely to run out of funds. Ask them about their volume of invoices and their capacity. Working with a well-financed company lowers your own risk.
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This is Paul, he is one of the directors of UVS, a labour-hire provider to the construction industry. Here’s what he has to say about how OptiPay was able to help his business grow and succeed. Contact an OptiPay expert today to see how we can help you.
OptiPay offers several different funding solutions and services, one or more of which charges no interest and has no long lock in contract period, called the Fully Flexible funding option. Conditions, fees and charges apply to some of the Services provided, which may change, or we may introduce new ones in the future. Full details for all funding options (Services) including any fees and charges which may apply, is available on request. Lending criteria apply to approval of credit products. This information does not take your personal objectives, circumstances or needs into account. Consider its appropriateness to these factors before acting on it. Read the funding agreements provided, for your selected funding solution (product/service), including all the Terms and Conditions contained in agreements provided, before proceeding. *T&Cs: Minimum 12-month invoice funding contract with OptiPay. Direct clients only, offer doesn’t apply to broker introduced clients. All standard credit terms and conditions apply including credit assessment. Not applicable to existing clients.