Summary: Invoice financing, also called invoice factoring, is a type of debtor finance that helps companies with cash flow problems due to slow-paying clients. It allows your business to finance invoices, which improves your company’s working capital.
Transactions are structured as the sale of accounts receivable rather than as a business loan. Consequently, they can be set up quickly and are easier to obtain than conventional loans. Small and midsize companies typically use this solution to improve their cash flow.
This article is a comprehensive tutorial about invoice finance. We cover the following subjects:
- Are you offering 30- to 60-day terms to clients?
- How does invoice financing work?
- Advance rates are important
- Typical invoice finance rates
- Does your business qualify?
- Benefits of invoice finance
- How to choose a finance company
- The invoice finance application process
1. Are you offering 30- to 60-day terms to your clients?
Do you have clients that take 30, 50, or 60 days to pay invoices? In today’s environment, most business sales involve payment terms. Terms can give your customers up to two months to pay an invoice.
Offering terms can create cash flow problems because many small and midsize companies can’t afford to wait that long for a payment. They need funds to pay for current expenses – like staff salaries and vendors.
The solution: Finance your invoices
Invoice finance solves this problem. It provides you with an advance on your invoices from slow-paying commercial clients. You get immediate working capital that you can use to pay for important expenses.
2. How does invoice financing work?
Most invoice finance companies structure their transactions as the sale of an asset. Your business sells the financial rights to your invoices in exchange for an immediate payment.
Finance companies buy your invoices in two instalments. The initial advance covers up to 85% of the invoice and is deposited to your bank account immediately. Note that the advance varies by industry and by company.
Once your customer pays, the finance company deposits the second instalment to cover the remaining 15%, less any financing fees. This payment settles the transaction for that specific invoice.
Most transactions follow these steps:
- Your company delivers the goods/services to your client.
- You submit an invoice for financing
- The finance company advances 80% of the invoice (this amount varies)
- Your client pays after 30 to 90 days
- The finance company issues the remaining 20%, less its fees
Read “How does invoice financing work” to learn more.
3. Advance rates are important
Most prospective clients focus their efforts on negotiating the lowest rates. However, the advance rate is just as important. The advance rate determines how much leverage you can get for your invoices and has a direct impact on your cash flow.
Advance rates typically go from 70% to 85% and vary based on your company’s and your industry’s risks.
4. Typical invoice finance rates
The cost of financing invoices varies based on the creditworthiness of your clients, the number of invoices you have, the size of the invoices, your turnover, and your company’s risk profile.
Most invoice financing companies charge an administration fee and an interest rate. The administration fee can go from 0.80% to 2.50% based on financing volume and risk profile. The interest rate, charged only on the utilised funds, is calculated using a base rate and other criteria.
Go deeper: Learn more by reading “How much does invoice finance cost? (detailed explanation)”
5. Does your company qualify?
Invoice finance has easier qualification requirements than most types of financing, such as loans or lines of credit. The two most important requirements are that your invoices:
- Must be due from reputable business clients
- Must not have any security interests (e.g., PPSA)
Also, your company should not have major issues, and management should have industry experience.
Go deeper: More details about invoice financing requirements.
6. Benefits of invoice financing
Invoice finance has a number of advantages over other types of small business financing. The obvious benefit is that it can improve your cash flow.
However, there are other benefits. Invoice financing is available to small businesses and can be deployed quickly. Additionally, the financing line is indexed to your company’s sales, so it can grow alongside your revenues.
Consequently, invoice financing can be a great alternative form of financing for entrepreneurial companies that are growing quickly but are running into cash flow issues.
7. How to select an invoice financing company?
Choosing the right financing company is a critical decision for your business. This decision should be made carefully. The following five\ points provide some guidelines for the process:
a) Avoid overwhelming yourself
One of the greatest mistakes that potential clients make is submitting an application to every finance company that they speak to. Submitting too many applications and managing multiple proposals can be confusing and take time.
Instead, contact a number of invoice finance companies until you find two or three that meet your criteria. Then, submit a full application to only those companies. This approach is more effective and provides you with more competitive financing proposals.
b) Is their proposal competitive?
The invoice finance market is competitive, which is good for clients. Consider getting quotes from at least two companies. Then, compare the quotes to determine which one offers the best value.
Note that price/rate is not the only thing you should be looking at. Review the proposals as a whole and compare them point by point.
c) How long have they been in business?
The first question to ask a finance company is how long have they been in business. In this industry, longevity matters. You want to work with a company that knows how to manage a client portfolio and can weather economic downturns.
Work with a company that has been operating for at least five years. Longer is better, obviously. It’s OK to work with a company that has been in business for less time. However, verify that it is owned and managed by experienced industry professionals.
d) Do they work with companies of your size?
Most finance companies advertise that they can fund companies of any size, from $30,000 to five million dollars. While they may have the funds to pursue these opportunities, they don’t always have the expertise.
The fact is that most finance companies have a preferred range, such as from $50,000 to $700,000. Only a few companies can actually handle a wide range of opportunities. As with the previous question, it’s best to ask the finance company directly.
e) Do they have minimums?
Most finance add minimum financing volumes to their contracts. It means that your company is contractually required to finance a minimum value while the line is in place. Otherwise, you must cover the difference in fees between what you financed and the contractual minimum.
Contrary to advertisements, minimums are not necessarily bad. Most finance companies provide you with better terms if you agree to certain minimums. As long as you are certain you will not break the minimums, they can get you lower prices.
Keep in mind that breaking a minimum is usually bad and affects your profits. If your plan has minimums, negotiate them carefully.
8. The invoice financing application process
Applying for a financing programme is much easier than applying for a commercial line of credit. As long as you have all the needed documents, the process usually takes a couple of days. Most finance companies ask for the following:
- An application
- ACN or ABN
- Recent aged receivables
Aside from asking for these three items, each finance company is different. Some may ask for other reports, while others won’t.
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