Managing cash flow is an ongoing task for any business owner and can be challenging at times. Cash flow stress can be due to a range of factors including extended invoice payment terms, clients slow-paying their invoices or simply the need for a short-term cash boost to take advantage of an attractive business opportunity. Even the most established and successful businesses can be confronted with cash flow issues, creating stress for the business owner, impacting growth and sometimes even the viability of a business. With this in mind, there is a good chance that you may one day need to access funds to keep your business sailing smoothly and this week's blog aims to help you better understand the difference between invoice finance and unsecured business loans.
The rise of the Unsecured Business Loan
Unsecured business loans have become a popular source of capital in the past 2-3 years with various players fighting for market share. According to Business News Australia, business owners now have over 20 unsecured loan suppliers at their disposal. And, considering banks have tightened their ‘lending belts’, the unsecured loan market is growing rapidly. So how does it all work?
An unsecured business loan can provide an injection of cash without having to pledge assets or property to the lender as security. This does however change for business loans greater than $50k - $100k where the lender often requires a charge over the business's assets, so the term 'unsecured' is not always accurate with bigger business loans.
Prospective lenders will consider trading history, turnover and credit history to work out the appropriate interest rate, loan amount and term of the loan. They'll collect and analyse financial data by scraping information from bank statements and occasionally by integrating with online accounting software. By crunching this data through their credit algorithms, lenders can quickly make credit decisions with business owners accessing cash within 24 to 48 hours of applying.
The term of these loans can range from three months to three years and repayments are generally made through direct debit on a daily or weekly basis. The cost of this type of borrowing can range from 20 per cent to 65 per cent per annum.
It is undeniable that gathering and crunching borrower data through clever credit algorithms to provide businesses with fast funding is brilliant and has an important place in the economy. The speed and accessibility of unsecured business loans does come at a premium though.
Firstly, the lack of collateral taken against unsecured business loans contributes to borrowing rates being relatively high. This is because if a small business fails – as more than 60 per cent of Australian small businesses do within their first three years – an unsecured lender will most times get very close to nothing back. If the lender has some level of security however, it can expect to get something more than nothing back and can therefore charge a bit less in interest and fees.
Secondly, business loans can be rigid and inflexible for business owners and once you pass the sugar high of getting the fast funds – you’re stuck with weekly or monthly repayment amounts that can sometimes become suffocating for your business.
How does invoice financing compare?
Invoice financing is a financial service tailored to cash flow management, closing the gap between the time of invoicing and invoice payment. It unlocks cash from unpaid invoices, allowing those funds to be used to invest back into your business sooner, often generating income that far exceeds the cost of financing.
Invoice financing should also give the borrower more control over their business cash flow. It brings forward funds that are already owed to the business and the finance is repaid when your invoices are paid – not through regular direct debits. Flexibility is also a nice feature of invoice finance as business owners can choose to draw funds against the whole ledger, some customers or even just single invoices.
The accounts receivable ledger is commonly the most valuable asset on a small business's balance sheet. By using this asset as security for invoice finance, there is no requirement to pledge property as collateral and the cost of finance is less than unsecured business loans.
How does invoice financing work?
Just like the unsecured business lenders, modern invoice finance providers are getting smarter at gathering and analysing data. Integration with cloud accounting platforms like Xero, MYOB and QuickBooks provides live invoice data to lenders and helps business owners and bookkeepers keep their books ship shape.
Invoice finance providers generally advance up to 80 per cent of the value of invoices upfront and when the invoice is paid, the extra 20 per cent is either returned to the borrower or used to pay off the loan facility. The rate of interest charged is generally between 10 per cent and 15 per cent per annum depending on the borrower and the credit quality of their customers. Modern invoice finance facilities, like Earlypay, charge a pay-for-what-you-use draw down fee but do not have ongoing facility fees or lock-in contracts.
Unsecured business lenders have an edge over invoice finance lenders for advancing the first round of funding but after the initial set-up advances against invoices are generally processed the same day. Another limitation of invoice finance, is that it requires the borrower to sell goods or services on credit to other solid businesses and to then invoice only after the goods have been delivered or service has been provided.
Which one is right for me?
It really comes down to the purpose of the loan and your overall business goals and objectives.
If you need a one-off cash injection to get your business off the ground or purchase a piece of equipment and there will be consistent cash flow to support loan repayments, then an unsecured business loan could be just what you need.
If your business is more established, has a strong accounts receivable ledger and you would like to bring forward some cash to use for business growth, then the flexibility of invoice finance might be just the ticket.
Understanding finance alternatives for your business is a challenge for many business owners. If you could do with some help to navigate through your options, contact our friendly team at 1300 760 205.