Invoice financing involves selling your unpaid invoices to a third party company for a fee. In return, they will allow you to draw funds against the money owed to your business. There are two main types of invoice financing: factoring and discounting.
Invoice factoring Invoice factoring involves handing your invoices over to an invoice financier, who will manage your sales ledger and collect money from customers on your behalf. When you raise an invoice, the invoice financier will purchase the debt owed to you by your customer, making a percentage of the cost (usually 85%) available to you upfront. The invoice financier then collects the full amount directly from your customer, making the remaining balance available to you. You will then have to pay the invoice financier interest and fees.
Invoice discounting Invoice discounting is similar to invoice factoring in that it enables you to sell your invoices to an invoice financier, who will lend you money against your unpaid invoices. However, in this instance, the invoice financier will not manage your sales ledger or collect debts on your behalf. When your customers pay their outstanding invoices, you will hand the money over to your invoice financier, reducing the amount you owe.
The pros and cons of invoice finance Invoice financing can provide your cash flow with a significant boost, which can be valuable if your business is lacking in working capital. However, the cost of using an invoice financier means that you will incur a reduction in your profit margin on each order or service you fulfil. Furthermore, your chosen invoice financier may restrict funding against poor quality debtors, which means that you will need to find a way to manage funding fluctuations.
Meeting the criteria for invoice finance Invoice finance requirements vary, so you will need to ensure your business meets a stringent set of requirements before you rush off to find an invoice financier.
Your business may be suitable for invoice finance if it has:
• A good spread of customers -- you may encounter funding restrictions if a single customer accounts for more one-third of your turnover • Simple, non-contractual debts • Low levels of debt more than three months overdue Your business may be unsuitable for invoice financing if it: • Sells products or services to the public -- invoice finance is only available for business that trade with commercial customers • Countless, small invoices • Complex, contractual debts
If your company exports goods, you may be able to benefit from a special type of invoice financing - export financing. When you use export financing, your chosen invoice financier will work with a partner abroad, who will be responsible for collecting payments from customers in the country to which you export.
Calculating the cost of invoice financing
If you are looking to use invoice financing, you should compare the interest charges, management fees and additional costs associated with each service provider. You should also consider the notice period for ending the service -- most financiers require at least three months' notice, but some have notice periods of up to 12 months.
Interest charges on invoice financing agreements work in the same way as bank interest. Most invoice financiers calculate charges daily and apply them monthly.
Management and administration fees for invoice financing will depend on several factors, including your turnover, invoice volume and the number of customers on your books. Factoring fees typically range from 0.75% to 2.5% of your turnover, while those for discounting range from 0.2% to 0.5% of your turnover.
Credit protection charges
If you enter into a non-recourse factoring arrangement, you will incur credit protection charges, as your invoice financier will be liable for any bad debts. Fees vary, depending on your financier's assessment of the level of risk. However, they typically range from 0.5% to 2.0% of your turnover.
Choosing an invoice financing provider
A wide range of financial institutions and independent providers offer invoice finance services, so it is advisable to approach more than one before you negotiate a deal. If you are unable to do your own research, you may wish to enlist the help of a broker, who will look into your options and negotiate a deal on your behalf
Funding Solutions is the brainchild of two highly experienced business professionals. Ian Hepworth is a career banker well practiced in delivering cash flow funding to both SME's and quoted companies from high street banks and specialist independent lenders alike.
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