According to research, cash flow worries keep 69% of small business owners up at night. What’s more, a further 32% cannot pay their vendors, bills, and employees thanks to cash flow issues.
Besides these findings, the study also revealed accounts receivable are one of the biggest causes behind cash flow problems.
Are you struggling to keep your business running thanks to outstanding accounts? Are your customers not paying you fast enough, and working capital is running dry?
If so, there is a cash flow solution you need to know about. Invoice financing.
Invoice financing, also known as invoice factoring is an easy way to activate the cash flow you need, while simultaneously cutting down collection work.
Are you curious to know what invoice factoring is and how it can help your business? Keep reading to find out everything you need to know about this age-old financing solution.
How Invoice Factoring Works
Invoice factoring is the practice of “selling” a business’s unpaid invoices for cash. The factor who purchases the outstanding invoices then collects them. They charge a fee for their services, which comes out of the total paid to the business.
Typically, factors pay an upfront percentage of the invoices. This can be as high as 90%. After they have collected the invoices, they then pay the business the remainder, less their invoice factoring fee.
The Two Different Types of Invoice Financing
Before you consider factoring, it’s important to differentiate between the two types of invoice financing. These are recourse and non-recourse invoice factoring.
With recourse factoring, the business is liable for the outstanding invoices. In other words, if the factor is unable to get customers to pay, the value of these invoices has to be paid back to the factor.
With non-recourse factoring, the factor shoulders increased responsibility for collection. There is a reduced chance you will have to pay a factor for invoices that turned into bad debts.
Generally, it is advised that you opt for non-recourse factoring. Non-recourse factoring is typically a safer choice.
If you are having cash flow issues, the last thing you want is to receive a large bill from a factor.
Also, with non-recourse invoice financing, factors are not as motivated to check your customers. With recourse invoice financing, factors meticulously check your customer accounts to make sure they have a good payment history and are happy with your business. This ensures a successful collection.
With non-recourse invoice financing, factors can hand back unpaid accounts and demand you to reimburse. This increases financing costs and is detrimental to cash flow.
How Much Does Invoice Financing Cost?
As with any financing solution, it’s important to know the costs involved.
Different factors have varying fees for their services. The best way to find out exact how much each invoice financing company charges and compare quotes from various factors.
When doing so, make sure that there are no hidden fees. The best is one, simple fee, that you can budget for.
If you can’t make sense of a factor’s invoice financing rates, this is a red flag.
Also, take note that recourse factoring fees are generally lower than invoice financing rates for non-recourse factoring. However, as mentioned above, non-recourse factoring can lose you money in the long term.
The Benefits of Invoice Financing
There are many benefits to invoice financing, especially for businesses that do not want to take on debt or are struggling to get other types of financing.
One of the primary benefits of invoice factoring is approval doesn’t rely on your business’s age, credit standing, or size.
The main thing that invoice factoring companies are concerned with is the quality of your accounts. If they are from customers with satisfactory payment history, you stand a good chance to receive invoice financing.
Another benefit to invoice financing is the approval time. While bank loan approvals can take anywhere up to 90 days, invoice factoring funds can be released within 24-48 hours. Take note that you first will have to be onboarded. However, this typically won’t take long, especially if you are prompt with your responses and have all of your relevant documents ready to go.
Additionally, invoice financing also frees businesses from an onerous administrative task—that of debt collecting. When you do invoice factoring, the factor takes on the job of collecting the outstanding invoices. This can free up considerable time and resources within your organization.
Lastly, one of the overarching benefits of invoice financing is it provides business owners with a way to turn a relatively non-liquid asset into cash. Research shows that European countries are particularly orientated towards trade credit. Approximately 70% of short-term debt in the UK is financed through trade credit. It also represents more than 25% of business assets in Germany, Italy, and France.
If you are sitting with a sizable amount of outstanding invoices, this could be holding you back from growth. Throttled cash flow means you can’t expand the way you need to. Invoice financing can turn this around by liquifying receivable accounts.
Drawbacks to Invoice Financing
There are, of course, some drawbacks to invoice financing. For one, you need to make sure the factor you choose employs acceptable and courteous collection methods. Otherwise, your client relationships and brand image may be tarnished.
Also, keep in mind that if your business can get very low-interest loans, invoice financing might be slightly more expensive.
Lastly, keep in mind that even if you choose non-recourse factoring, you still retain some liability. In the event a factor really cannot collect an account, you might need to reimburse the factor.