Are you in trouble with your cash flow because of dues of payable amount from your customers? Do you not know that you can borrow money against the amounts due from your customers through invoice financing?
Invoice Financing is a way for your business to loan amount of money against the due amount from your customers. Then sustain the salaries and fringe benefits of employees, sustain the supply chain of suppliers and roll-out investment in operations. Hence, waiting for the 100% full payment of customers will slow down your production and sales. In the long run, it will cause problems in your business operations.
Invoice financing is also known as “accounts receivable financing” or “Invoice factoring.”
Understanding the context of Invoice Factoring
Customers that purchase a large volume of products in wholesale or retail would likely access your credit package. As the business owner, one way to get to the competition is to allow credit line to prospect costumers. The customers will receive the invoice that has the total amount due and due date that usually given 30 days to settle. However, offering credit to customer draw-up funds that a business might otherwise use to invest in growing the operations. The company will choose to finance the invoices to smoothen the cash flow.
For example:
Tad’s Construction Supply Ltd. won a bid to supply a house construction project. Tad has to pay the purchase of supplies from his leading supplier, extra operation costs and other staff for this project. However, he will only get the payment when the delivery of all materials are completed.
Tad is owed £50,000 by his materials’ manufacturer to complete the project. The invoice to his customer has a payment term of 30 days. Tad’s will agree to an invoice finance agreement that will give him 85% of the invoice upfront, with total fees at 3%.
When Tad shows the invoice to the lending firm, he will receive an advance payment of £42,500 for a couple of days. By the time the customer pays the invoice, the full amount of £50,000 will go to the bank account of the lender. Tad will get the remaining value of the invoice £7,500 minus the fee of 3%.
The structuring of Invoice Financing
The credit platform is commonly structured on either factoring or discounting.
Invoice Factoring
A financial product that allows businesses to sell unpaid invoices to a third party factoring lender. The third party will collect the accounts receivable of your customers. Thus, lender might pay the company (seller) 70% to 85% upfront of what the invoices are ultimately worth. Assuming, when the lender receives the full payment for the invoices, the lender will remit the remaining 15% to 30% of the invoice amounts to the business. The business that borrows will pay interest and fees for the service.
Advantages:
- Outsource sales ledger management, freeing up time to manage the business
- You will be forced to do credit checking and engage with customers that pay on time
- A quick and safe source of cash flow by financing accounts receivable
- Lower time spent on administering late payments since the factor assumes the responsibility of collecting the debt
- Less expensive than turning to equity investors
- Can improve your client’s payment performance on a long-term perspective
Disadvantages
- If the lender is unable to manage debt collection, it will affect the image of your company
- Can change the relationship to your customers by the time they will know a third party will collect their debt payments
- The costs are higher compared to a bank loan. It will work only for business with high profit
- Reduce the scope of additional borrowing
- Handing over the responsibility to collect to the third party will give up your element of control
Invoice discounting
A form for financing where a business owner agrees to sell the unpaid invoices to a third party. The business will be able to access all money in advance through leveraging the sales ledger. It has been popular in improving the working capital cycle.
Invoice discounting is flexible and adapts to the changes and growth of the business. This financing platform is better when compared to traditional forms of loans and overdrafts.
The invoice financier will not manage the sales ledger of the company nor the collection of debts. Instead, the financier will lend the company an amount of money against the unpaid
invoices. They will come with an agreed percentage of the total value. The company is still responsible for the collection of debts.
Advantages
- The company can choose what invoices to sell. It would suit if one customer demanded a credit term to the remainder of the sales portfolio. If a company customer demand for 90 days credit terms, invoice trading can access the cash on this invoice platform.
- Accelerates cash flow because you don’t need to wait for the payments of your customers
- No need for any high valued assets to get the funding
- Arranged confidentially to preserve your relationship with customers
- More cash than a traditional business loan
Disadvantages
- Customers may prefer to deal with you directly
- It can affect how customers view trust in the company
How does Invoice factoring work?
1. Submit the invoice details to the agreed provider
2. The provider will pay the agreed percentage often in 48 hours
3. If approved, you will chase payment or provider will do the chasing
4. You will receive the remainder of the invoice amount once full payment is received.