Invoice finance 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 of funding around which there is much debate because it has many obvious advantages as it does disadvantages. But the fact that it’s a finance route popularly used highlights the critical role it plays in managing business cash flow in today’s world.
Cash flow is possibly the single most crucial 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 with seemingly large outgoings and perhaps less generous payment terms from debtors.
Invoice finance gives companies the option to inject working capital into their operations, enabling them to overcome the cash flow barriers they face. Given the importance of cash flow issues, this could explain why it is so commonly used.
For many, invoice factoring is a short-term solution for temporary cash flow problems. However, there are instances where ongoing cash flow advances will be a required, continual support for growing businesses. With this in mind, could invoice finance act a longer-term tool?
In this blog, we aim to answer that very question.
- What is invoice finance?
- What should I consider before using invoice finance?
- Can invoice finance be used long-term?
What is invoice finance?
In its simplest form, invoice finance is a way for businesses to borrow money based on outstanding amounts due from its customers. Invoice discounting or factoring lenders 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 advances of typically between 80 and 90% of the invoice values, in addition to a handling fee and interest on the money borrowed.
It comes in two forms: factoring gives control to the finance provider and the fact that you are using finance is disclosed to your clients. Confidential invoice discounting allows you to keep a sense of confidentiality as customers continue to pay you, you carry out credit control and the third party lender involvement is undisclosed.
It is straightforward and incredibly beneficial for solving the cashflow problems associated with customers taking a long time to pay. If you are a small business working with suppliers that have shorter payment terms than the time it takes you to collect in your invoices, then you will have constant cashflow challenges. 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.
What should I consider before using invoice finance?
While invoice finance (or factoring) carries excellent benefits for those who use it to address cash flow issues, there are careful considerations to make before using it.
You must make sure that the customers you are dealing with are robust and reputable in their own right. This is because an invoice financing company will almost certainly carry out a level of due diligence before taking on the debt. They will need to be reassured that they are going to get their money.
Similarly, you must be confident that a factoring company’s involvement will not affect your reputation with your customers; there can be a stigma around invoice financing, even though it is becoming an increasingly popular form of financing.
If you are using factoring, there may be additional considerations. 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 cannot factor their debt and they are also responsible for recovering the debt, which makes you one step removed.
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 financing company to ensure that the benefit of the cash advance does not cost 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.
It is important to go and seek a number of quotes in the marketplace to ensure that you get the best terms and make sure that you compare terms to ensure you receive the deal most suited to your business.
So, it is essential to weigh up the pros and cons and make sure the associated costs are worth it to improve your cash flow.
Can invoice finance be used long-term?
Whether you want to use invoice finance long-term will depend on how comfortable you feel with the associated fees. In an ideal world, your cash flow will always run smoothly, removing the need for financial help – but realistically, there may be more than one occasion where you require an injection of capital into your business to address cash blockages.
However, long-term continuity and business survival require people to see invoice finance as part of the bigger picture. In this sense, it is an excellent solution to beating the cash flow demands of early-stage development or business growth. It, therefore, does have value as part of the toolkit SMEs have to address blockages in their finances and prevent them from worsening.
When all is said and done, businesses are in it to make money; good profits allow people to make a living. Companies need to continue to exist in the short-term to make money in the long-term. In essence, a consistent cash flow will allow you to continue production, increase sales and generate revenue. So, invoice finance may be a short-term solution, but it packs a long-term punch.
Get advice
Invoice finance is just one of the many solutions available on the lending market to those looking to boost their cash flow. If you are seeking support in this area, it is essential to do your research to identify the right option for you.
At Pegasus Funding, we offer advice across a variety of funding types and put funders into competition for your business. Using our knowledge, we can discuss your needs and pinpoint the best finance sources to solve the issues you face.