As a small business owner, you probably strive to balance your cash inflow and outflow to generate sufficient working capital. You can leverage your outstanding invoices or Bills Receivable (BR) to meet your operational expenses.
What is Invoice Financing?
Though invoice financing is not technically a loan, it works on the same principles. Factoring companies offer to purchase your invoices at a discounted value, offering you instant cash. The burden of collecting against the invoice is then transferred to the factoring company.
Discounting, Factoring and Financing
The terms invoice financing, invoice factoring and bill discounting are often used interchangeably. There are, however, some distinct differences among them. Financing is a broad term that refers to releasing the funds locked in outstanding bills. The differences between factoring and discounting include:
|Transaction||You essentially sell |
your invoices to the
|You get a loan |
|Ownership||The lender assumes|
ownership of your
sales ledger and
relieves you of the
burden of collection.
|You retain ownership & |
|Control||The financer takes |
|Your business retains |
|Privacy||The customer becomes aware of third-party |
transparent to the
|Impact on Business||Knowledge of |
|No knowledge of |
translates to no impact on existing customer
Benefits of Invoice Financing
The biggest and most significant advantage of invoice financing is that it instantly releases funds for working capital. Some of the more subtle or tangential benefits include:
- Invoice financing requires no collateral. You could think of it as a collateral-free finance option.
- Finance is available whenever you need it. The process of invoice financing is usually completed within 24 hours, releasing cash immediately.
- Invoice financing has a cyclical effect on business growth. As your turnover grows, so do your BR, which translates to more finance. More finance translates to business growth and higher turnover.
- Using invoice factoring to pay your suppliers promptly gives you a bargaining chip – reducing the material cost.
- Factoring relieves you of the burden of collection – freeing up resources for other tasks.
- If you use discounting, your customers are unaware of any third-party involvement. Thus, your credit rating gets a boost – from both, the customers’ and the suppliers’ perspective.
- Factoring companies charge competitive interest rates and provide not just finance, but also supportive guidance for business growth.
When Should You Use Invoice Financing?
Businesses like construction, manufacturing and wholesale trade have inherently long credit lines. Conversely, the working capital demands of these businesses are heavy. Invoice financing can resolve this imbalance.
Likewise, startups and small businesses struggle to recover receivables and pay suppliers. Invoice financing is the answer to their dilemma.
Invoice financing can drive business growth by putting your revenue back to work in the business while retaining your goodwill and credit worthiness so that you can continue to attract new customers and service the existing ones.
Invoice financing comes as a beacon of rescue to any business by bridging the gap between receivables and payables and freeing up working capital for the business.
“Am I Eligible for Invoice Factoring or Bill Discounting?”
Whether you are a small business or a large corporate, any business can opt for invoice financing. There are a few regulatory requirements, and most financing involves an agreement between parties. You must consider a few things, though, before you jump in.
Invoice financing translates to a deal in which the lender essentially takes over the risk of your outstanding debts. Any lender will, therefore, seek assurance that the bills will be recovered sometime shortly. To this end, financers and factoring companies may demand any or all of the following:
- Proof that your business is run efficiently
- Proof that your clients – those to whom owe you money – have a good credit rating
- Proof that you have not previously discounted the same bills to another lender
To provide the said proof, you will need to supply any or all the following documents:
- Your financial statements for the past two or three years
- Your documented collection process
- Bank statements
- Proof of identity
- Projected income and expenditure
- Other documentary proof as may be demanded by the lender
If you have all the documentary evidence at hand, the process of invoice financing can be completed within 24 hours.
Factoring or Discounting – Which should you choose?
This is a call that every businessperson must take after carefully considering all variables. Specifically, you may ask yourself certain key questions:
- “Why do I need the funds?” You should opt for financing only if you are unable to fund your business activities internally from your revenue – albeit with credit lines. You should also consider whether you are looking for a one-off solution – perhaps to fund a particular project – or regular financing options. Factoring works when you are looking for a single lump sum amount which you can explain to your debtors and who will be aware of third-party involvement. If, on the other hand, you are looking for a steady inflow of cash against receivables, or if you have seasonal, but regular demand for working capital, it would be advisable to work with a bill-discounting partner.
- “Why do I need invoice financing?” If you need a constant source of financing because, for instance, your business is expanding, invoice discounting may be the right option for you, provided you can manage the collection of payments. However, if you need it for a specific purpose, such as meeting payroll or to fund a particular project, then invoice factoring may better suit your needs.
- “Do I need collection services?” If you struggle to collect your receivables regularly, you may be well advised to opt for invoice factoring. In particular, Small businesses may lack the resources for credit management and collection. Such businesses may also have heavy receivables and low working capital. Invoice factoring brings relief to such enterprises.
- “What would the funding cost?” The cost of invoice discounting can be hefty since you are not only giving up a small part of your revenue but also incurring collection cost. Factoring, on the other hand, eliminates collection costs; although revenue loss – which may be viewed as a fee for credit management – will still apply. If you are looking for a periodic discounting solution, you may have to incur additional set-up costs.
- The Size of the Business – As mentioned earlier, large turnover translates to more bills to discount, which in turn translates to more funding for business growth. Your decisions regarding invoice financing will be based upon the resources available, your ledger management process, and your turnover. Collection services that come with factoring can be high if your turnover is small. Conversely, small businesses may not have the resources for collecting bills, and services offered by factoring companies may prove helpful. Larger businesses may prefer to manage their own ledgers and opt for bill discounting.
- Loan Eligibility and Credit Rating –Startups and small businesses usually have low credit ratings and do not qualify for bank loans. They do not have sufficient assets to put up as collateral. On the other hand, clients expect and demand long credit lines. In this situation, invoice financing can offer much-needed relief.
Invoice financing leverages your business activity providing you immediate return on sales. It eliminates the need for costly business loans and funds operating costs.