Invoice factoring - good for the short-term or the bigger picture?
Invoice factoring is known to be the oldest form of alternative financing used in businesses. And it still plays a key role today. It is a form financing around which there is much debate because it has as many obvious disadvantages as it does advantages. But the fact that it's a finance route used by many, highlights important role it plays in today’s world of managing business cash flow.
Cash flow is possibly the single most important cog in the business machine. And for many businesses, fulfilling financial-related commitments can often be a thorn in their side. This is especially true for SMEs who have seemingly large outgoings and perhaps less generous payment terms from debtors.
So, is it just a quick fix?
In its simplest form, invoice factoring is a way for businesses to borrow money based on outstanding amounts due from its customers. Invoice factoring companies basically act as a source of funding and take on the responsibility to obtain payment from your customers, on your behalf. You hand over your invoices in exchange for instant advances of up to 100% of the invoice value, but typically between 80 and 90%, in addition to a handling fee and interest.
It is straightforward. And particularly beneficial to solving the problems associated with customers taking a long time to pay. If you are a small business working with suppliers that have short payment terms, your incomings aren't going to be sufficient to cover your outgoings. In short, obtaining funds in this way allows you to go about your daily business with one less worry. You can pay employees and suppliers, reinvest in operations and plan for growth much earlier than you could if you’d had to wait for customers to pay you.
You must make sure, however, that the customers you are dealing with are robust and reputable in their own right. This is because an invoice factoring company will almost certainly carry out a level of due diligence prior to taking on the debt. At the end of the day, they will need to be reassured that they are going to get their money.
Similarly, you must be confident that the involvement of a factoring company will not affect your reputation with your customers; there can be a stigma around invoice factoring, even though it is becoming an increasingly popular form of financing.
Because their invoice will no longer be payable to you, customers will be aware of your evident need for a quick cash injection. For most, this won't be an issue. But for some, it may pose questions around your stability and future trading ability. You will also lose an element of control with your customers, especially in situations where they prove to have a bad credit rating. Factoring companies could stipulate that you no longer work with them, or at least define the boundaries within which you can work with them.
And these rules won’t come for free. As with all forms of financing, there is a cost to pay and you need to be aware of what you are signing up to. Do your research and choose a respectable, well-regarded factoring company to make sure that the benefit of immediate cash is not costing you more than the profit wrapped up in the invoice. In general, you will pay charges of between 1 and 3% of the cash advanced, inclusive of administration fees.
But this may be more than worth it, if your actions today help achieve bigger picture tomorrow. When all is said and done, businesses are in it to make money; good profits allow people to make a living. Businesses need to continue to exist in the short-term in order to make money in the long-term. In essence, a consistent cash flow will allow you to continue production, increase sales and generate a revenue.
There is no doubt that invoice factoring provides a short-term quick fix for cash flow management, and is often the saviour of many small businesses. But to maintain a good reputation with your customers, it may not be the best long-term solution.
However, long-term continuity and business survival require people to see invoice factoring as part of the bigger picture and, in this sense, it is a great solution to beating the cash flow demands of early stage development or growth maintenance.
For more information on alternative debt and equity funding, including invoice factoring, call Pegasus Funding Resources today on 0207 327 0567.