Small business owners are often challenged when a large customer requests 30 to 90 days of credit to pay an invoice. As a business owner, you want to offer credit terms because it improves your ability to sell to large clients. However, offering credit terms can also hurt your company if you don’t have financial reserves and cannot wait four to eight weeks to get paid.
This article explains how to solve this challenge using invoice financing. We cover the following:
- The cash flow dilemma
- Why would a company sell its accounts receivable ledger?
- How does invoice financing work?
- Can I sell any of my invoices?
- How much does it cost?
- How quickly can I get financing?
1. The cash flow dilemma
These conflicting payment interests pose a dilemma for business owners. You must take clients on credit to grow your business. But taking clients on credit can create financial problems. This is a risky way to grow a business. The decision to offer credit terms is not easy, especially for small companies without financial reserves.
There is, however, a way to offer credit terms without risking your cash flow. You can finance your net-30 to net 60 term accounts receivable by selling them to a company that specializes in invoice financing.
2. Why would a company sell its accounts receivable?
Few small business owners are aware that they can sell their invoices to improve their cash flow. However, receivables financing is a well known solution among larger companies.
Larger companies use this option because it reduces the time between providing a service (or product) and getting paid. This strategy improves their cash flow, enabling them to meet corporate expenses.
Invoice financing lines have many advantages and few disadvantages. Most lines are flexible and can grow as your sales grow. They are also easier to get than business loans.
These features make invoice financing an attractive option for small companies with great potential but without a lot of tangible assets.
3. How does invoice financing work?
Invoice financing, also called invoice factoring, is a type of debtor finance. It is simple to use and requires only a few days for the initial setup. Once the account is set up, your company can finance invoices as needed.
a) Find a debtor financing company
This type of financing is commonly offered by debtor finance companies. Some banks have internal debtor financing divisions; however, they often work with larger clients only. Most debtor finance companies are small to midsize businesses.
b) Negotiate a contract/agreement
Once you have selected a company, you need to negotiate a financing contract with them. The contract stipulates essential details such as the rate, advance, minimums (if any), and term length. The term length of contracts varies by provider and transaction details. Seek competent legal advice when reviewing your contract.
c) Select invoices that need funding
Once a contract is in place, you can select the clients whose invoices you want financed. Then, the debtor finance company evaluates your client’s credit and determines if the invoices can be funded. Most debtor finance companies buy invoices from creditworthy commercial clients who pay in 30 to 90 days.
d) Send out the notices of assignment
Once the credits are approved, the finance company sends a Notice of Assignment (NOA) to each of your selected customers. Sending a NOA is a standard process among all debtor finance companies.
e) Finance the invoices
Once the account is set up, you can use it as often as required. Most invoice sales to a debtor finance company are financed in two instalments. You get the first instalment, usually 80% of the invoice, when you submit the invoice to the debtor financing company. You get the remaining 20%, less the financing fees, once your customer pays the invoice in full.
The first instalment is often called the “advance.” Advances average 80%; however, they can range from 70% to 85% based on your industry, volume, and other details of the transaction. Read “How does invoice finance work?” to learn more.
4. Can I sell any invoice?
Debtor finance companies do not buy overdue invoices or invoices with a high risk of not getting paid. Those types of invoices are best handled by using debt collection companies or lawyers.
Instead, debtor finance companies buy invoices from customers that will pay – but will take 30 to 90 days to pay. Invoice finance is considered a tool to improve cash flow, not a tool to manage troubled invoices.
Debtor finance companies evaluate the business creditworthiness of the invoices you want to sell, which helps determine their quality. They also review the contract terms of the invoice to determine when it’s payable and if there are any potential issues.
Additionally, any invoices you sell to a finance company must not be pledged as security for other transactions.
5. How much does financing invoices cost?
The cost of financing your receivables varies based on the volume of invoices, their creditworthiness, and your industry. Debtor finance companies typically charge an administration fee for every invoice and an ongoing interest rate on the advanced portion. Read “How much does invoice financing cost?” to learn more and see an example.
6. How quickly can I get funded?
Most clients can get their first batch of invoices funded shortly after their account is set up. The first funding may take a few days. However, subsequent invoices can usually be funded on the same day or so, as long as they are submitted early and can be verified quickly.
Need more information?
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Marco Terry is the Managing Director of Commercial Capital LLC and has over two decades of experience in asset-based finance. He has worked with small and mid-sized companies across the United States, Canada, and Australia. Marco holds a Master of Science in Finance.