A business that relies on invoicing its clients for payments can run into issues with cash flow. This common problem can hobble growth, as it becomes difficult to keep up with mounting operational expenses.
If your business finds itself sitting on a sizable amount of unpaid invoices, there is a way to collect these much-needed funds. The solution is invoice financing!
If you have ever heard of invoice financing or invoice factoring, then you may have asked yourself, is this a good idea? The answer is an absolute yes!
How Does Invoice Financing Work?
First, it is essential to understand a few details. There are two versions of this unique financial product: invoice financing and invoice factoring. It is important to get clear on how the two are different so you can decide which may be better for your company.
Also known as “accounts receivable” financing, this works primarily by using your receivables to secure the loan. Instead of having to use your property or some other asset as collateral, the lender, or factoring company in many cases, uses the unpaid invoices as collateral.
You borrow the majority of the invoiced amount and pay it back, usually with a fee and over several months. The factoring company does not collect on the invoice directly. It is a relatively easy process.
Factoring is a bit different. Instead of loaning you the money directly, the factoring company fronts your business a percentage of the invoiced amount. At this point, they will take over the collection process of the invoices.
In this arrangement, the factoring company is essentially purchasing your outstanding invoices. They will check your customer’s credit and collect the unpaid amount directly from them. In this case, they will act as a third party entering into the mix.
Benefits of Invoice Financing
Invoice financing and factoring are two of the more overlooked finance tools out there. Many businesses would benefit significantly from freeing up the cash stuck in unpaid invoices.
Here are some of the many benefits:
1) Cash Flow: A company with operating expenses usually finds it painful to let invoices go unpaid for the typical 30-60 day waiting period. The larger the client, the larger the invoice, and the more likely your cash flow will benefit from having immediate access to the funds.
2) Growth: With more access to cash comes freedom. Freedom to focus proactively on growth rather than chasing all the money your clients owe you.
Whether it’s acquiring new customers, extending more credit to loyal clients, or getting the word out through marketing campaigns, more liquidity makes it easier to expand.
Armed with the option to finance invoices, a company can confidently take on larger, more expensive projects that might otherwise be risky.
3) Functionality: With cash, a company can pay bills vital to operating so it can function more smoothly. This can bode well for companies that rely on supply chains, for example. The ability to pay suppliers on time can prevent chokes in the supply chain that slow down production.
4) Stay Out of Debt: While invoice financing is technically a loan, it’s not a typical loan you might otherwise rely on. With factoring, there are no long-term contracts or fixed-term payments since the factoring company collects directly from your customer.
Not being bogged down by credit, and not having to fend off creditors, means your company can focus on what it does best.
5) Easy Approval: The application process is streamlined so that a factoring company can approve a business within days, even hours. After all, what point is there to a lengthy application process when your company needs to access cash right away?
Flexibility of Invoice Financing
Additionally, invoice financing gives your business more control over revenue. You won’t always need to finance invoices, and you may not need it with every customer. There will be times when you may need to finance more.
Having options means you can decide exactly when it is most appropriate. Financing your accounts receivable is one of the best tools to leverage your business’s finances.
How Much Does Invoice Financing Cost?
The fee to finance and factor invoices is around 3%-5% of the invoice amount. The main difference between the two is how you repay them.
With invoice factoring, you won’t receive the entire invoiced amount right away. Instead, you’ll receive around 85% (though this can be as much as 90%) of the invoice. The remaining 15%, less the 3% fee, comes when the factoring company collects on the invoice.
When you finance an invoice, you receive the entire amount upfront. Then you can pay back the amount in monthly installments, which includes the 3% fee.
Here is an example of invoice factoring a $20,000 invoice.
- Invoice value = $20,000
- Invoice fee (3%) = $600
- Initial advance (85%) = $17,000
- Remaining amount (12%) = $2,400
As you can see, it is a win-win situation. If a few hundred bucks means your company will have the cash it needs to stay afloat, then it is well worth it.
There is a reason why so many industries choose invoice financing as a way to bridge the gap between when an invoice is sent to a client, and when the client pays the invoice. It is some of the most accessible business funding around.
Drawbacks of Invoice Financing
Invoice financing and factoring can be a real lifesaver for many small business owners. However, there are a few minor drawbacks.
For one, only businesses-to-business (B2B) companies can take advantage of this type of financing. The invoice amount must be large enough to make it worth the factoring company’s efforts. Invoices worth tens of thousands of dollars are almost entirely exclusive to B2B companies.
What types of businesses can take advantage of invoice financing? Industries like trucking, construction, staffing, and manufacturing. Invoice financing is mostly unavailable for companies that invoice individuals rather than businesses.
Enter a Third Party
Invoice factoring involves the presence of a third party, the factoring company. While your customer may understand the need for an outsider to get involved with the financing aspect of the relationship, be aware that some customers may not welcome it.
Invoice Financing Improves Cash Flow
Time is money, and the precious weeks it takes to get paid for an outstanding invoice means increased friction and lost productivity for your company. Invoice financing removes this friction and helps your business operate more smoothly.
Contact us today at 704-904-0774 to speak with a financial advisor and learn how to tap into this valuable financing resource.