Last Updated On May 18th, 2023.
Invoice Finance, also known as debtor finance and accounts receivable financing, is a category of business funding solutions. It enables a business to access a line of credit upfront by using its outstanding customer invoices as collateral.
For businesses needing to increase cash flow to meet short-term liquidity needs, this type of financing can be hugely beneficial.
Why use Invoice Finace?
Businesses with access to Invoice Finance can utilise funds owed to them in the form of outstanding invoices much faster than if they had to wait for customers to pay.
These financial facilities can similarly be used to quickly raise capital so that a business can pay suppliers, meet payroll, cover overheads, and reinvest in long-term growth.
Invoice financing can be a critical tool in helping businesses overcome cash flow gaps caused by extended payment terms and/or seasonal sales cycles. It can provide predictable and reliable working capital to ensure cash flow meets the needs of operational costs or rapid growth.
Is Invoice Finance used in Australia?
The use of Invoice Finance in Australia is increasing. However, compared to other countries this relatively unknown form of financing is still underutilised.
For example, Invoice Finance volumes total 3.9% of GDP in Australia, compared to 19% of GDP in the UK.
This is despite Australian businesses suffering from amongst the highest rates of late payments and extended payment terms globally. According to ASBFEO, Australian companies are paid 26.4 days late on average. Contrast this with an average of 5.85 days late in the UK and 7.1 days late in the US.
In the ScotPac SME Growth Index Insight Series – Rebounding from COVID-19: towards 2021, we asked SMEs to name the top three factors that would help small and medium-sized businesses rebound from the COVID-19 recession.
Federal Government legislation on 30-day payment terms was the second most popular factor, named by over 46% of small businesses.
Invoice Finance helps SMEs to bridge the gap in cash and time between raising an invoice and receiving payment.
Types of Invoice Finance
Invoice financing encompasses various options, and it’s crucial to understand their differences. Of the many invoice financing options for SMEs in Australia, the solutions all fall into two categories: factoring and discounting.
1. Invoice Factoring
Invoice Factoring involves the sale of the accounts receivable ledger (i.e., outstanding invoices) or selected invoices from the ledger.
The financial institution then provides up to 95% of the outstanding invoice value as an advance. While the remaining balance, less fees incurred, is transferred after collection of the payments.
This type of financing can be beneficial for small and medium-sized businesses that don’t have a dedicated internal collections department but do not require strictly confidential finance arrangements.
The reason for this is because the facility provider (i.e., ScotPac) becomes responsible for collecting the outstanding invoices and controlling the credit. Your customers will usually be aware of your relationship with the finance company.
2. Invoice Discounting
Invoice Discounting similarly allows a business to access a line of credit using its accounts receivable as collateral.
Normally, unlike with factoring, you can access up to 85% of the value of your outstanding invoices upfront. Like factoring though, the remaining balance, less fees, is released once payment has been collected.
Discounting is generally more suited to large and medium-sized businesses who both require confidential finance arrangements and have a reputable, capable and established accounts and collections department.
With Invoice Discounting facilities, you retain the responsibility for collecting unpaid invoices.
3. Selective Invoice Finance
Selective Invoice Finance allows you to choose which invoices you want to finance (i.e., to be used as security for the cash advance). Selective Invoice Finance is also referred to as spot factoring and can benefit SMEs with a small volume of high-value invoices rather than larger business trading in high volumes of small-value invoices.
If your business sells to larger clients on net terms, you can smooth over the gap between raising an invoice and receiving payment by turning selected unpaid invoices into an immediate cash flow injection.
Pros and Cons of Invoice Finance
When considering funding options, it’s essential to weigh the pros and cons of invoice financing compared to alternative funding solutions and even loans from banks.
The pros of Invoice Financing are that they offer flexible access to funds, improved cash flow management, and the ability to leverage outstanding invoices.
However, invoice discounting and factoring can be more expensive than traditional funding options as there may be additional fees involved.
It’s critical that you evaluate the advantages and disadvantages of Invoice Financing and understand what is best for your particular business and financial goals.
Understanding the Fees
While fees may vary among providers, typically these include discount fees or interest charges based on the financed amount.
Additional fees, such as administration fees or credit check fees, may also apply. Make sure to compare the costs of any proposed Invoice Finance arrangement with other funding options to ensure you’re making the right, informed choice for you and your business.
Comparing Invoice Finance vs. Unsecured Business Loans
Unsecured business loans provide companies with a one-off lump sum to borrow. The money loaned is repaid through a series of regular repayments over a set period and is subject to pre-arranged interest.
Business loan providers, such as banks, lending institutions and financial organisations, often require applicants to have been trading for a minimum period to qualify for a loan.
In addition, there may be other eligibility criteria such as demonstrated evidence concerning how you will repay the loan amount. It’s also common for applicants to be required to provide a personal guarantee, especially with traditional lenders such as banks.
Compared to unsecured business loans, Invoice Financing is much more flexible. There’s no need to worry about fixed repayment terms and the funding provider receives repayment when your customer settles the invoice.
The cost of an Invoice Finance facility is typically calculated as a percentage of the total invoice value. Invoice Finance is generally regarded as less risky for the lender as a result of the use of accounts receivables as collateral. This often means it is more cost-effective than an unsecured loan, especially for smaller or medium-sized businesses.
Invoice financing is also more accessible to startups and SMEs with ATO debt or for those businesses that fail to meet the strict lending criteria for a business loan.
What is the Eligibility Criteria?
Invoice financing is a flexible funding solution that can help businesses of all sizes and across many industries improve access to cash flow.
It’s important, though, to understand the general eligibility criteria. One crucial aspect is the creditworthiness of a business’s customers, as the finance provider assesses the risk associated with the outstanding invoices.
For Invoice Discounting, you may also require a robust and capable accounts receivable and collections department as you will be controlling the payment collection and outstanding invoice follow-ups.
There may be a minimum volume of invoices required to qualify for financing which could disquality some micro-businesses.
We recommend having a discussion with our finance specialists to find out whether your business meets the minimum criteria to unlock the benefits of invoice financing.
The Application Process
The application process may differ from provider to provider but typically involves submitting relevant financial and business information, and sharing details about the invoices to be financed.
The time it takes to get approval and receive funding can vary but generally ranges from 48 hours (as in the case with ScotPac) to days or weeks.
Here at ScotPac, we leverage the latest technology and cloud-based programs to ensure our clients are able to access the working capital they need as quickly as possible.
Impact of Invoice Financing on Customer Relationships
One concern businesses may have when considering Invoice Financing is its potential impact on customer relationships. While involving a finance provider in collections may introduce a third party and can cause some concern, in reality transparent communication can mitigate any negative effects on your relationships with customers.
In fact, invoice financing can positively impact customer relationships by ensuring timely payments and allowing businesses to offer more favourable payment terms. Ultimately, maintaining open communication and delivering quality services are the key to preserving customer satisfaction and securing future business whether or not you utilise Invoice Financing.
Will My Customers Know That I’m Using Invoice Finance?
Many finance companies offer confidential Invoice Discounting facilities. Generally, Invoice Discounting is more suitable for established companies with an in-house collections team. In such a case, there is no reason why and no way for customers to know that you’re using such financing arrangements.
Disclosed Invoice Factoring is typically more suitable for businesses that could benefit from outsourcing collections to the invoice financing provider. While confidentiality is compromised, there are many reasons why a business may prefer the factoring option.
What Happens if My Customer Doesn’t Pay the Invoice?
At the end of the day, it all depends on the terms of your funding arrangement.
In most cases, you will be responsible for the costs of any bad debt. The finance company will carry out due diligence before approving an invoice for funding to minimise the risk of non-payment by ensuring the credit ratings of your customers passes their minimum acceptance level.
You can also use Bad Debt Protection to safeguard your business from the risks of customer non-payment. Make sure to ask your local ScotPac business finance specialist for more information.
Is Invoice Finance Right for Your Business?
The answer is: It depends.
Here at ScotPac, we offer a range of flexible solutions that can be tailored to the needs of any business. As a business owner, you can choose to go with a come-and-go facility with no lock-in contracts or a full-service facility that includes collection and account management services as well.
Ultimately, our specialist team will work with you to understand your needs and find the best financial solution to suit your business objectives. Between the breadth and depth of our support and guidance and our commitment to working with our clients as partners, you can rest assured our team will help you choose the right type of business and/or Invoice Finance for your needs.
As a general guide as to whether Invoice Financing is the best option for your business, consider that a short trading history or low credit rating can often mean traditional funding sources are out of reach for many small and medium-sized businesses. Therefore, Invoice Finance may be a much more accessible source of funding and better suited to small and medium-sized businesses. The finance company will primarily look at your customer’s credit rating and ability to pay rather than your company’s.
If you supply larger businesses on net terms, Invoice Finance can be a great way to fill in cash flow gaps between payments with easily accessible working capital. That’s why, this type of financing is the go-to for businesses needing a fast source of financing.
But it’s not just about the short term. You can use your improved cash flow to reinvest and generate more profit than the invoice financing cost and to fund longer term growth and expansion. Invoice Finance can be just the fuel your business rocket needs to take off and it’s used as a cost-effective funding solution by many Australian SMEs in a wide range of sectors for just that reason.
ScotPac Invoice Finance
ScotPac Invoice Finance can help you to transform your outstanding invoices into instant funding with our range of flexible options. In fact, our efficient and dedicated team of relationship managers will assist you in setting up a tailored financial facility.
At ScotPac, we prioritise the growth of our clients and ensure their successremain at the heart of all of our services. For that reason, we’re proud to say that our clients experience a growth rate that is three times faster on average than other Australian businesses.
To discuss the potential benefits of Invoice Finance for your business, make sure to reach out to our team today.