Introduction: What is invoice financing?
Invoice financing is a relatively broad term encompassing many finance facilities put in place to enable businesses to mitigate cash flow challenges caused by delayed payments from customers. This means companies don’t have to wait until their account receivables are paid in full. Instead, they can sell their invoices to investors for a reasonable percentage of the net value and use the cash to pay wages, suppliers, and to spearhead the growth of the company.
Typically, there are two main types of invoice financing, which are:
- Invoice factoring
- Invoice discounting
Invoice financing is an invaluable finance tool that allows businesses to access as much as three times more cash compared to other traditional forms of funding. Furthermore, borrowing power tends to increase in direct proportion to turnover.
How does the invoice finance process work?
Invoice financing is a straightforward procedure that can be outlined and carried out in four easy steps:
1. After providing goods or services to your customers present them with an invoice as per standard practice but with the additional action of forwarding a copy of that invoice and any requisite details to your invoice finance provider.
2. The invoice finance provider then pays you according to specified agreement terms. The payment usually occurs within 48 hours, and the total amount is typically a percentage of the net value of the invoice.
3. The provider can handle the credit control and collections processes on your behalf, or you can choose to pursue the outstanding payments on your own if the customer delays payment.
4. Once the customer settles the balance, your business then receives the rest of the cash due for that invoice after the provider pockets their service charge fees or any other charges stated in your agreement.
Selective invoice finance
Sometimes called single invoice finance or spot factoring, it merely refers to a situation whereby businesses sell only a separate, specified invoice to a third party at a discount instead of subscribing to a ‘whole sales ledger’ facility. This arrangement is preferable when a large, individual invoice is involved since it helps to unlock a large sum of cash that can quickly boost cash flow in critical situations.
Benefits of invoice finance
- It helps to safeguard businesses from the risks associated with customer insolvency, delayed payment and non-payment of invoices.
- It offers easily accessible funds, more borrowing power, and flexibility relative to traditional and inflexible forms of funding such as business loans and overdrafts.
- Furthermore, borrowing power increases with turnover, which allows growing businesses to access more funds.
- Companies can quickly decide to sell their invoices with fast returns.
What costs are involved in invoice finance?
It is crucial for businesses to intimately understand the fine print on all applicable costs, rates, fees, plus any other hidden charges stated in their contract. Extra caution is required since this section of the financial industry is unregulated. Generally, invoice factoring and discounting involve two standard charges:
- Service charge
The service charge is also called the credit management fee, but it includes administration costs as well. The amount is usually between 0.75% and 2.5% of the company’s gross turnover.
- Discount charge
This fee is similarly structured to interest payments on a bank or business loan or perhaps an overdraft. The charge is, therefore, a calculated percentage of the total invoice value and is applied daily once the funds are released to you. The discharge fee ranges from 1% to 3% over base rate and can be paid weekly or monthly. It all depends on the terms set forth by the provider, but the bottom line is, you incur more charges if your customer delays payment.
Who is eligible for invoice finance, and what are the requirements?
The key requirements and eligibility terms for invoice finance can be summarized in terms of your business having or doing the following:
- It should be registered as a limited company or LLP
- It should trade with other business and not directly with consumers
- It should offer credit terms approved by industry standards
- It should record a minimum turnover of £50k
- It should be able to send a minimum number of invoices per month if the provider sets down this requirement
Invoice finance is not regulated. What should you look out for?
Accounts receivable financing is an industry that does not currently enjoy the prudent regulation offered by the Financial Conduct Authority in the UK. This means that providers don’t have their operations and conduct governed by the FCA, which may be an unfavourable situation for business clients. Thus, borrowers are encouraged to stay on the safe side by ensuring their contracts contain the following:
- Binding terms should not exceed the maximum duration of 12 months
- A specific and clearly stated termination clause should be included
- The termination fee should not amount to more than two months’ worth of minimum service fees
- All other applicable fees should be clearly outlined with no hidden costs
Bad debt protection
Bad debt production is a product that can be added as a bolt on to an invoice finance facility. It is credit insurance that protects businesses by paying them what is due from customers who default on their invoices. The responsibility for the unpaid amount is taken over by the provider at a cost. It also provides options for the lender to assume control of the credit management process and for businesses to utilize bad debt protection on specific, individual invoices.
Import invoice finance
Import Invoice Finance is a specialized import financing solution that enables businesses to obtain working capital while they wait for goods or raw materials they purchased from overseas to be delivered. Importers can use this quickly accessed cash for reinvestment and other expenses that help to keep business flourishing.
Invoice trading is an entirely online process whereby businesses sell their account receivables to obtain cash flow relief while they wait for their customers to pay for the goods or services they received. This peer-to-peer lending process efficiently links buyers and sellers from all over the world since it occurs via easily accessible online auctions.
Why has invoice finance attained quick growth and success?
Invoice finance is not a recent phenomenon. However, in the last five years, it has firmly and effectively established itself as the go-to finance tool for businesses seeking quick injections of cash flow that also help to promote expansion. Many businesses made the switch to invoice financing once banks started setting down stricter and increasingly inflexible terms. In 2008 alone invoice financing had a total number of approximately 68 000 business followers up from 50 000. Since then the industry has increased at a rate of almost 400%. Third-party financiers usually include individual investors and various institutions.
Invoice financing owes its success partly to the high risk of unpaid invoices associated with many industries. This primarily affects SMEs since larger companies are known to sustain their operations using cash flow input obtained from smaller companies. Several statistical factors point to this:
- The aggregate amount for unpaid invoices has been climbing on an annual basis and now stands at approximately £67 billion.
- 22% of this amount from unpaid invoices is due from large companies, a trend that has been in place since the recession
- The percentage of SMEs receiving payments that have been delayed for more than a month increased by 9% between Q2 2014 and Q2 2015. This is according to Experian reports, but currently, this percentage is likely to be more.
Is Invoice finance designed for small businesses?
Invoice finance is a highly suitable and viable form of funding for small businesses and start-ups. Traditionally recognized forms of funding extend their services only for companies that meet their strict trading records and credit score requirements. It is true that finance providers and factors also advance more funds more readily to businesses with lower risk. Still, overall, the industry’s principles of quick injections of cash flow is a beneficial aspect that is applicable to any and all businesses regardless of turnover.