A guide to invoice financing, and how to choose the right provider for your business.
A critical part of running a successful business is maintaining enough cash flow to pay for operational costs, purchase inventory and invest in assets to help your business to grow.
A common reason for SMEs not having a comfortable amount of cash flowing through their business is that it's tied up in unpaid invoices. This happens when businesses sell to their customers on credit terms and the agreed terms are long and/or customers choose to delay payment past the agreed due dates. Having done the hard part and made the sales, it can be frustrating for business owners to wait an unreasonable amount of time to actually receive the cash.
In previous blogs, we've provided some tips to get your invoices paid sooner but even when businesses adopt the gold standard of receivables management processes, many find that the cash isn't arriving soon enough.
This is where invoice financing companies, like Earlypay, come in. They allow for the early payment of outstanding invoices, so business owners can have certainty around when cash from their sales will come into their business.
Here is everything you need to know about how invoice financing works, and how to choose the best invoice financing provider for your business.
What is invoice financing (aka debtor financing)?
Invoice financing is a type of business finance that is also known as debtor financing. This type of business finance allows businesses to access the cash tied up in their unpaid invoices without any restrictions on how the funds are used in the business.
As invoice financing is backed by unpaid invoices, the more invoices a business makes available for financing, the more funding the business can access. And because the accounts receivable are the main security for the finance, there is no need for real estate security and there is no minimum time in business required, making invoice finance a popular choice for start-ups.
The invoice financing provider will generally advance up to 80% of the value of invoices upfront and the remaining 20%, less any fees, becomes available to the business when the invoices are paid. Bringing forward the cash flow from unpaid invoicies using debtor financing gives certainty around cash flow that many business owners crave why it's a fast growing business financing solution in Australia.
How to choose the best invoice financing company for your business
Below we look at the different types of debtor financing and the important considerations that business owners should take into account when choosing an invoice financing provider.
1. Invoice factoring versus invoice discounting
Before choosing the best debtor financing provider for your business, it's important to understand the difference between invoice factoring and invoice discounting. Although they are both types of invoice financing that use a business' accounts receivable as security, there are some key differences.
Invoice factoring (aka debt factoring)
Invoice factoring, sometimes known as debt factoring, involves the 'sale' of unpaid invoices to the financier who generally assumes responsibility for managing payment collections. For many business owners, this is a major benefit as it allows them to outsource this function and use that time in other areas.
In many cases, invoice factoring is 'disclosed' meaning that your customers know that there is a financier involved. This often encourages customers to pay their invoices sooner as they know they're dealing with independent collections specialists who have already heard every late payment excuse under the sun! Disclosed invoice factoring is not always the case though, and sometimes invoice factoring companies offer confidential invoice factoring services although this is often only available to stronger businesses.
Invoice factoring can also include additional services such as credit checking your customers, arranging trade credit insurance and allocating invoice payments to the relevant invoices.
Because the factoring company is focused on the financed invoices being paid in full, they carry out a high level of due diligence on the invoices. This makes the quality of the invoices and debtors much more important to the lender than the strength of the business being financed so factoring can be a great tool for start-ups or businesses that don't have a strong credit history.
Invoice discounting uses a business' accounts receivable as security for a loan which is different to invoice factoring which involves the 'sale' of invoices to the invoice factoring company. This effect of this subtle difference is that a business using invoice discounting retains control over the accounts receivable ledger, specifically with managing invoice collections and customer contact. This requires a capable in-house collections team which is often only the case for bigger businesses. Invoice discounting also generally requires the business itself to have a strong history of profitability as the lender has less control over the invoices than with factoring and therefore relies more on the strength of the business to repay the loan.
2. Selective invoice financing versus whole-of-book invoice financing
Single invoice financing, selective invoice financing or spot factoring, all refer to the financing of one or a selection of invoices. This can be a useful tool for small businesses that have the occasional need for a small amount of finance.
Whole ledger, or whole-of-book invoice financing, is generally a longer-term arrangement that maximises the amount of finance available to businesses by using the full amount of unpaid invoices. Typically, this is structured as a business line-of-credit and the business can access finance against the value of the full ledger as required.
3. Invoice finance costs
As is the case for all types of business finance, interest is payable on the outstanding finance amounts for most types of invoice financing. Fees can differ depending on the type of financing though.
For selective invoice financing and some modern whole-of-book invoice financing arrangements, a fee is charged at the time of drawing finance and can be a percentage of the invoice value or drawn amount. This pay as-you-go structure provides a lot of flexibility although it can often work out to be more expensive than other arrangements in the long run.
The alternative is an administration fee which is payable on the amount of invoices financed. This is very common for factoring arrangements as the fee includes collections, trade credit insurance and other services in addition to financing. This pricing structure allows for consistency from month-to-month which assists in budgeting and is often more cost effective in the long run.
When comparing pricing from one invoice financing company to another, it's important to carefully compare the services included, as what might appear cheaper can quickly become more expensive if you account for the time you spend doing things yourself.
4. Online accounting software
Cloud accounting software providers like Xero, MYOB and Quickbooks have brought huge effciency benefits to SMEs including how they can access invoice financing more simply. The leading invoice financing companies now integrate with the most popular cloud accounting platforms to track invoice information, making it simple to access finance without the need to upload accounts receivable ledgers. If you use Xero, MYOB AccountRight or Quickbooks Online, it's important that you choose a modern invoice financier that links to your accounting software as it can save many hours of work every week.
For businesses that don't use an online accounting platform mentioned, don't despair! Invoice financing companies have been providing their services for decades and the good ones will fit in with your processes to make things run as efficiently as possible.
5. Flexibility is key
SMEs come in all shapes and sizes and there is no single financing solution that is right for all businesses. Its important to find an invoice financing provider that is flexible and can work with you to find the best solution for your business.
Whether it be invoice financing or invoice discounting, confidential or disclosed, additional services included or excluded, draw down fee or admin fee, online connectivity or traditional processes, a good invoice financing provider will work through the various options to tailor a structure than fits with you and your business.
6. Strong reputation
As is always the case in business, you'll want to work with businesses and people that you trust and support you with provide reliably good service. Before you commit to an invoice financing provider, it's important to ask around and get confidence that you are making the right decision. This might be through asking friends, industry contacts, your accountant or broker, or checking online reviews from existing clients.
Invoice financing is growing fast in Australia as it's arguably the most flexible type of business financing available. It can cater to most businesses that sell on credit to other businesses and invoice after the goods or services have been delivered. And because the finance is secured by the invoices themselves, there is no need for real estate or a long trading history.
Invoice financing has many benefits for SMEs and we hope that this information helps you find the debtor financing provider that is best suited to supporting your business.
If you would like to learn more about Earlypay's invoice financing services, please visit us at earlypay.com.au or speak to your Broker or BDM.