What to know about factoring your outstanding invoices with a third-party provider.
Any business, big or small, can run into issues accessing working capital due to unpaid client invoices. Fast growing businesses in industries with long payment cycles in particular are very likely to face problems having too much working capital tied up in their accounts receivable.
According to Brian Hamilton, Founder of US-based company Sageworks, this is a serious challenge for fast-growth businesses.
“The biggest challenge I’ve seen for fast-growth companies is that their accounts receivable run faster than their sales or their ability to collect.”
“You could have – and you do have – cases where the company’s growing, they’re even profitable, but because they’re not collecting their accounts receivable quickly enough, they go out of business or they have big problems.”
Not only is a lack of working capital a hindrance to the growth of any business, but chasing up customers to pay invoices can be time consuming and strain professional relationships. This is where invoice financing solutions, such as invoice factoring, come into play.
Invoice factoring involves selling all, or some, of your accounts receivable to an invoice factoring company, who provides upfront payment for your invoices. This is typically in the form of a line of credit and the financier advances around 80% of the value of the invoices, with the remaining 20% paid to your business upon full invoice collection, minus a factoring fee.
Let’s take a look at how invoice factoring may help business owners struggling with cash flow issues.
5 key things you must know about invoice factoring:
1. You can outsource the collections process
Some financing solutions, such as business loans or invoice discounting, see businesses retain control of the accounts receivable ledger and responsibility for chasing up clients for payment. Invoice factoring can be a saviour for those looking to avoid this completely.
By handing over your accounts receivable ledger to a third party, the payment collection process is taken over by professionals who are experienced in managing collections, relieving your accounts department of the task and freeing up time and money for alternative focusses. Customers can often be more receptive to paying invoices on time when there is a third-party being involved too.
2. It’s more flexible than a business loan
If the source of your cash flow problems is working capital that's tied up in upaid invoices then it makes sense to use a type of finance that's purpose built to help business owners with this challenge.
Compared to business loans for example, invoice factoring, is a flexible solution that facilitates early payment of invoices. Where a business loan is a lump sum payment that requires regular and fixed repayments, invoice factoring is an ongoing arrangement that lets you access finance against your invoices when you require the additional working capital to support your cash flow.
Business loan providers may also have strict eligibility requirements that your business may not satisfy, such as a long and profitable trading history. Because invoice factoring uses your unpaid invoices as security, invoice financing companies are mostly concerned with the amount and quality of your business' outstanding invoices.
This is why some invoice factoring companies, including Earlypay, may still approve businesses with short trading histories, less than perfect credit scores, or ATO debts.
3. You don't need to use real estate as security
One of the biggest benefits of invoice factoring over other business financing solutions, such as bank loans and other types of business loans, is that you do not need to offer up real estate as loan security. With invoice factoring, your debtor ledger is the collateral and there is generally no requirement for security over assets outside of the business. This is something that many business owners appreciate as they can keep their business and personal affairs separated to a large extent.
4. It can help seasonal businesses
Seasonal businesses already struggle enough with managing cash flow in off-seasons. When you add unpaid invoices to the mix, cracks may begin to form.
As payments slow down, your cash flow can become stagnant and it becomes progressively more challenging to afford necessary costs, retain staff or say yes to new projects and clients. In those slow months when every dollar counts, receiving early payment of your invoices using invoice factoring may help seasonal businesses keep their heads above water.
5. Effectively managing accounts receivable is critical
The process of chasing and collecting unpaid invoices can easily take up hours of a workweek. The more debtors you have, the more hours you or your accounts receivable team are spending in the collections process. But managing the collection of your invoices is critically important for all businesses. It's no good making sales on credit if you never see the cash.
A survey by the Australian Small Business and Family Enterprise Ombudsman reported that 20% of businesses had to wait an average of 60 days to be paid. The survey also found that the chances of collecting an outstanding amount is only:
- 69% after 90 days,
- 51% after six months, and
- 21% after 12 months.
As you can see, the longer spent chasing up an invoice, the less likely it is to be paid. But the hours put into the collections effort have already been diverted away from areas that would have been of better service to a business. By outsourcing the often tedious, but very important job, of invoice collection, you’ll be able to increase work productivity significantly.
6. It can increase work productivity
As we discussed in our recent blog, 7 ways invoice factoring can boost productivity, there are other benefits to using invoice factoring including having the factoring company carry our credit checks on your customers and to arrange trade credit insurance in case your customers default.
Invoice factoring is now much simpler than in the past as the leading invoice factoring companies, like Earlypay, link to online accounting providers including Xero, MYOB and Quickbooks to access your invoice information in real-time which eliminates many of the manual processes required in the past.
If you would like to learn more about Earlypay’s invoice factoring services, and other ways that we can help to unlock working capital from your unpaid invoices, please visit us at earlypay.com.au, visit our sign-up form, or speak to your Broker or BDM.