Invoice financing is a way of getting cash in advance from your unpaid invoices, without waiting for your customers to pay. It can help you improve your cash flow, manage your working capital, and grow your business. But how do you use invoice financing effectively and avoid common pitfalls? Here are some best practices to follow.
There are two main types of invoice financing: factoring and discounting. Factoring means you sell your invoices to a third-party company, who collects the payments from your customers and pays you a percentage of the invoice value upfront. Discounting means you borrow money from a lender using your invoices as collateral, and you pay back the loan plus interest when your customers pay. Factoring is more suitable for small businesses that need immediate cash and don't have strong credit ratings, while discounting is more suitable for larger businesses that have more control over their collections and want to maintain their customer relationships.
Not all invoice financing providers are the same. They may offer different rates, fees, terms, and services. You should compare different providers based on their reputation, flexibility, transparency, and customer support. You should also check if they have any industry-specific expertise, such as in construction, manufacturing, or retail. You should look for a provider that can tailor their invoice financing solution to your needs and goals, and that can provide you with online access, reporting, and feedback.
Use the invoice finance market to your advantage. It is important to structure a facility that will work and provide unrestricted funding. Look out for things like concentration limits or export caps which might restrict funding. Then look at pricing. Compare the facilities that work. Look beyond headline rates and look at total costs. Disbursements can add up. Not all lenders charge all the fees that some might. Remember to review the facility annually even if only to benchmark. As your turnover increases the percentage fees should reduce. To save time and get the best deal use a reputable broker.
Make sure if you use a factoring company it is not a bank factoring program. Underwriting is so much different then a traditional factoring company.
You don't have to finance all your invoices. You can choose which ones to finance based on your cash flow needs, the creditworthiness of your customers, and the payment terms of your invoices. You should finance the invoices that have the highest value, the longest payment terms, and the lowest risk of default or dispute. You should also finance the invoices that are related to your most profitable products or services, or that can help you secure more orders or contracts. You should avoid financing the invoices that have low value, short payment terms, or high risk of non-payment or dispute.
Selecting only some invoices to finance may be false economies. If you are selecting individual invoices the rates can be high. Using a whole turnover agreement can in fact be more cost effective. However, if you look to not notify certain invoices it may be false economies. Let's look at an example. If you want an invoice finance facility for a ￡1m turnover business, the lender may decide to charge a service fee of ￡10,000. That would be 1% on each invoice. To save money you may decide you only want to notify half your turnover. The lender may still want ￡10,000 as a service fee. The service fee would then be 2% on each invoice. Not an exact science but an important principle.
Invoice financing is not a one-time solution. It is a continuous process that requires you to monitor your invoice financing performance and adjust your strategy accordingly. You should track your invoice financing costs, benefits, and risks, and compare them to your cash flow projections and goals. You should also review your customer payment behavior, and identify any issues or opportunities for improvement. You should communicate regularly with your invoice financing provider, and seek their feedback and advice. You should also evaluate your invoice financing provider's performance, and switch to another provider if you are not satisfied.
Invoice financing is not a substitute for good invoicing and collection practices. It is a complement that can help you bridge the gap between issuing invoices and receiving payments. You should still optimize your invoicing and collection processes to ensure that you get paid on time and in full. You should issue your invoices promptly, accurately, and clearly, and include all the relevant details and terms. You should also follow up with your customers regularly, and remind them of their payment obligations and deadlines. You should also have a clear policy and procedure for handling late payments, disputes, and bad debts.
Invoice financing can be a powerful tool to improve your cash flow and grow your business. But you need to use it wisely and strategically. By following these best practices, you can make the most of invoice financing and avoid common mistakes.
Good invoicing and collection practices will help you secure the best possible invoice finance facility. Look at your audit trail that supports invoices. The more 'water tight' it is the better. make sure you get purchase orders, signed proof of deliveries, signed timesheets where relevant and other relevant documents. These will help enforce debts when there are disputes and will give lenders confidence in you.
Invoice financing is a valuable tool for businesses, especially those with extended payment terms, to enhance cash flow. It involves converting unpaid invoices into immediate cash, enabling businesses to meet financial obligations and invest in growth. Two primary types are factoring, where invoices are sold to a company for upfront cash, and discounting, involving borrowing against unpaid invoices. Factoring suits businesses with irregular cash flow, while discounting offers more control. Comparing providers is crucial, considering factors like rates, fees, and services. Strategic use of invoice financing involves analyzing cash flow patterns and avoiding overextension.
An important consideration is future proofing your facility. Will you be starting to export? You need a lender that will fund those exports. Will you be taking on a large customer that might dominate the debtor book? If so, you need a concentration limit large enough to accommodate this. Look beyond your business today and try to predict any potential changes. You will likely be signing up for 12 months so make sure the facility will work.