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What is Invoice Finance?

Very simply, invoice finance is money that is advanced against the value of your invoice, and then repaid upon payment by your customer minus the administration charges from the lender.

Thus, if you have £50,000 of invoices outstanding, you will be paid up to £45,000 immediately. Once the full £50,000 has been paid to the lender, they will give you the £5,000 balance less their fees. You can therefore get the benefit of your customers' payments even though their credit term is not yet up. You can do this using one of two different types of invoice finance:   invoice factoring and invoice discounting.

Traditionally, some Invoice finance customers have used Late payment as a trigger for invoice finance because, although your company may have assets tied up in your invoices, customers that hold back invoice payments can seriously affect your cash flow. This is particularly the case with new businesses that need the cash to continue trading during the first few difficult weeks of their existence, and also with businesses that are experiencing rapid growth.

Irrespective of the value of your invoices, you have to pay for raw materials and wages until they are paid.  Let's say you offer 30-day terms and your customers stick to that, you still have financial commitments during these 30 days.

Late payment is generally a trigger for invoice finance because, although your company may have assets tied up in your invoices, customers that hold back invoice payments can seriously affect your cash flow. This is particularly the case with new businesses that need the cash to continue trading during the first few difficult weeks of their existence, and also with businesses that are experiencing rapid growth. Even standard 30-day credit terms for customers can financially embarrass many companies, new or established.

Irrespective of the value of your invoices, you have to pay for raw materials and wages until they are paid.  Let's say you offer 30-day terms and your customers stick to that, you still have financial commitments during these 30 days that only an established company with steady cash flow will have been able to plan for.

Invoice and Assets

Many businesses, particularly small businesses, don’t use financing facilities against their invoices, instead opting for more traditional overdraft facilities from the bank, or in some circumstances even using personal funds. The key thing to remember is that your company should use a facility that is flexible, and linked to the turnover of the company (not normally seen with an overdraft) so that funding works to assist business growth and cashflow.

You Need Cash to Expand!

So, in a nutshell, you can be owed a great deal of money but still have pressing financial commitments of your own. If your business is expanding faster than customers are paying, you will be pressed for payment, both by your own suppliers and also by your employees who expect a regular cash flow into their bank account every week or month. Where is this cash to come from?  You will need finance until your business is either established or there is a good stable relationship between cash in and cash out.

In invoice finance, the security for the finance is the debtor book: basically, you can receive a cash sum to improve your cash flow from a provider who then collects the outstanding invoices from your debtors. You should receive around 80 - 90% of the value of your outstanding invoices that can be used to level out the normal variations in your cash flow.

This does not mean 'collection' in terms of bad debts, but simply that they receive the payments when they are due and then pass them on to you.

Invoices are Assets

Many businesses, particularly small businesses, fail to regard their outstanding invoices as assets that are easily realizable over the short term. By receiving this cash, you can have it when you most need it, and the balance of the difference between the values of the invoices and the sum you receive is provided to you once the invoices have been paid, minus, of course, the administration fee charged by the lender.

Thus, if you have £50,000 of invoices outstanding, you will be paid up to £45,000 immediately. Once the full £50,000 has been paid to the lender, they will give you the £5,000 balance less their fees. You can therefore get the benefit of your customers' payments even though their credit term is not yet up. You can do this using one of two different types of invoice finance:   invoice factoring and invoice discounting.

 

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Invoice Finance: Invoice Factoring

In invoice factoring, the factor offers finance based upon a proportion of your outstanding invoices: up to 90% in most cases. The factor also provides the credit control, which saves you the cost of hiring a credit controller. It is the factor's responsibility to collect the money due on the invoices.

Once you have supplied the customer with the goods or services ordered, you invoice them and also send a copy of the invoice to the factor.  The factor then collects payment according to the contract with the customer, including any credit terms offered as part of the contract. You are then immediately paid the agreed percentage of the invoice, the factor deducts the fee
when the invoice is finally paid and you receive the balance.

This type of invoice finance takes the entire collection process out of your hands, and saves you on staff salaries. You can compare the factoring cost against the cost of hiring a credit controller and decide if you want this as a temporary or permanent arrangement.
Using factoring, a new business can get cash immediately they issue their first invoice, and can maintain a steady cash flow in accordance with invoices issued.

Invoice Finance:  Invoice Discounting

Invoice factoring might not be suitable where the profit margin from individual invoices is particularly low, because the factor's fees will be deducted from the invoice payment. It is of specific value to businesses, however, since it does not require employee time to be spent chasing up invoices - all that is done for you.

However, what if you already have credit control or collection staff? What should you do then if you need your cash freed up? Larger businesses with their own credit control departments generally find invoice discounting more suitable.

You could get a bank overdraft to help you with cash flow at certain times of the year, such as having to stock up with summer goods, but you can also use a form of invoice finance known as invoice discounting. This is more common with medium and large businesses seeking a better means of financing this period than an overdraft.

Discounting is similar to invoice factoring; only you carry out the collection using your own credit control department. Small businesses do not generally employ dedicated credit control staff. In fact, large businesses frequently use invoice discounting as a means of invoice finance on a regular basis. They then have more control over their cash assets and can plan future expansions or acquisitions from a sound financial base, knowing that invoice payments will not be an issue.

Summary

Invoice finance is a means of freeing up cash that would otherwise be tied up in invoices, and can be used as a permanent means of invoice collection or just where there is a seasonal need for extraordinary expenditure.  Rapid business expansion is another reason for a need to realize the cash tied up in invoices, and the cost of doing so is generally lower than an arranged bank overdraft or regular bank loan.


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