Updated 1st July 2024
For small businesses, a delay in receiving payment from customers and clients is one of the leading causes of gaps in and problems with cash flow.
Invoice Financing, which is also referred to as Debtor Finance or Accounts Receivable Financing, is a short-term financial solution that helps businesses access the money owed to them tomorrow, today.
But how does it work and is it right for you? In this blog, we will break down the pros and cons of Invoice Financing.
Understanding what Invoice Financing Is
Before considering whether Invoice Financing is right for you, it’s important to ensure we understand what it is. Let’s play out how it works step by step.
1. Credit is extended
Once your business has provided goods or services to a customer or client, you issue an invoice and extend credit to them. This means that because they have yet to pay you there is a gap in your cash flow.
2. Sell your invoice
Invoice Financing means you basically sell your invoice to the finance provider at a discount. This can range from 70% to 95% of the total outstanding value.
3. Receive capital
Now the finance provider will give you the agreed percentage amount of the invoice or invoices due immediately to help you cover cash flow gaps.
4. Receive the remaining balance
Once your customer or client settles the outstanding invoice, you will receive the remaining balance owed to you minus any administrative fees involved in the Invoice Financing agreement.
What are the Pros and Cons of Invoice Financing
Pro 1 – Improved Cash Flow
Invoice Financing can be a real lifesaver for businesses that are growing quickly or are experiencing cash flow management issues as a result of delayed invoice payments. This solution means your business can access the money locked up in invoices sooner rather than later and can cover ongoing operating expenses or invest in growth as required.
Pro 2 – Extended Payment Terms for Customers
With Invoice Financing, you can access the money owed to you as soon as possible and you can offer customers extended payment terms. This allows your business to be more competitive in the marketplace, win new businesses and continue along the path to success without being affected by generous payment terms.
Pro 3 – More Accessible Working Capital Solution with No Collateral
Invoice Financing is a good option for businesses that may not have the strong credit history required for a traditional bank loan. Invoice Financing is based on the creditworthiness of one’s customers and clients, rather than on one’s own history. This can be a very important advantage for small and growing businesses.
Similarly, because there is no need to put up security or collateral, Invoice Financing is far more accessible for a wider range of businesses. It allows business owners to access however much they need whenever they need it.
Con 1 – There are Financing Fees to Consider
Invoice Financing may not require collateral or robust credit histories but there are still financing fees. Every financial provider will have their own fee structure and this will be included in the initial agreement you enter. In general, there are three main types of fees associated with Invoice Finance.
- Factor Rate – This is the percentage of the invoice value that the finance company charges to purchase your invoice(s).
- Transaction Fee – This is the flat fee that is charged for the financial solution.
- Account Maintenance Fee – This is the monthly fee charged to keep the Invoice Financing account open.
Con 2 – Invoice Financing is Not Suitable for All Industries
Not all businesses are able to access Invoice Financing. If your customers and clients tend to have poor credit history or engage in a high rate of returns, Invoice Financing may not be suitable. Similarly, if you don’t work in an industry where you issue invoices of significant value (such as business-to-consumer industries), Invoice Financing will not be available.
Con 3 – Invoice Financing Does Have Recourse
Recourse simply refers to the fact that if your customers or clients default on their payment, you may still be responsible for repaying the invoice(s) to the finance provider. Of course, financial providers conduct due diligence before engaging in an Invoice Financing arrangement. Nevertheless, the risk can never be entirely mitigated. If this is a concern of yours, you might want to consider some bad debt protection.
Should Your Business Use Invoice Financing?
There is very little question that Invoice Financing is a helpful tool for businesses looking to improve their cash flow management. Nevertheless, it may not be right for every business.
It is important to consider the pros and cons and decide what is right for your business, your industry, your goals and your needs.
What to consider before arranging Invoice Financing
Ask yourself the following questions:
- What are your business’s cash flow needs?
- How urgently do you need access to the capital locked in outstanding invoices?
- What would be the cost of Invoice Financing to your business?
- Are your customers creditworthy?
- Is there a more suitable alternative financing option?
Why you should speak to the ScotPac team today
ScotPac is the largest non-banking lender in Australia with 8000+ businesses supported by our financial solutions currently and $27.3 billion invoices funded annually!
Over the last 35 years, our team of lending specialists have assisted many businesses in reaching their growth and operational goals using Invoice Financing. Whether you’re wondering whether Invoice Financing or a conventional bank loan is right for you, or you just want to find out more about the ins and outs of this financial solution, get in touch with our team today for a confidential, obligation-free consultation.