How Invoice Financing can work for business

If your startup or SME has a revenue system based on invoicing it can be extremely frustrating. Waiting for your invoices to be paid – especially when customers default – can run down an otherwise viable business. The money you’ve extended as credit to your customers represents funds you can’t put back to work in your business right away, which ties up your working capital.

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This is basically what invoice financing – aka accounts receivable financing – can do for your business. Invoice financing is not the best, cost-efficient way to finance your business operations. It tends to be expensive and so is perhaps not a long-term financing strategy. However, it can provide you with better cash flow predictability. Use invoice financing to ease the burden on your business if you’re running short of capital or urgently need to meet other expenses.

How does invoice financing work?

Once you agree to sell an invoice to the financing company, they generally will advance you about 85% of the total value of the invoice. The remaining 15% of the balance will be held in reserve. From this reserve amount, the financing company will collect their first fee (similar to a processing fee, it can be around 3%). The invoice financing company next charges a “factor fee” that will depend on the intervening time between the funds being granted and the invoice being paid. The fee is invariably calculated on a weekly basis. For example, a factor could charge 1% each week until the invoice is paid. Once your customer pays the invoice, you will receive the reserve amount, minus the total fees accumulated.

Courtesy of RBS’ Invoice Financing Blog

The above explanation is the norm, but there are invoice financing companies that will simply advance you 100% of an outstanding invoice. In this case. you’re required to reimburse weekly, with fees, over a set period of time – usually around 12 weeks – until the advance is fully paid off. This gives you an extra boost and is therefore slightly more costly. Also, this method does not regard whether your customers settle their debts or not.

There is an easy-to-read case study from Alternative Business Funding that illustrates what prompted one entrepreneur to opt into invoice financing.

What does invoice financing cost?

Let’s say you have a £10,000 invoice with 30-day terms. An invoice financing company may immediately advance you 85% of that amount (£8,500), holding £1,500 in reserve. The customer then pays the invoice 2 weeks before the due date. After subtracting the 3% processing fee (£300), the invoice financing company would keep its factoring fee, which is 1% per week the invoice was outstanding (in this example that would be 2% or £200) and give you the remaining £1,000. In primitive terms, the invoice financing company sold you £9,500 at £10,000.

Courtesy of RBS’ Invoice Financing Blog

Some basic ways to make invoice financing work

To many entrepreneurs invoice financing is a necessary evil. The problem is not that your business is failing. The problem is simply that you don’t yet have cash from a sale. It’s a shame to have to lose a portion of your potential revenue just because of that. Some things you can do to make invoice financing work for your business are:

  • Factor potential invoice financing costs into your product/service pricing. This way you share the burden with your customers. The whole point of invoice financing is to provide a degree of cash flow predictability. Think ahead about how business operations could be affected, what the costs of various solutions may be, and put that into your price tag. If a customer pays early, you simply have a larger margin.
  • Offer discounts and other rewards for early payments. After understanding invoice financing a little more, you can better empathize with this sales tactic. It’s the same logic as in the point above – think ahead. Let’s be real: better have a 5% discount than have to pay an invoice financing company 5% of your sales. In the former case you engender loyalty in your customers, in the latter case you only make less money. If you can reach the point where invoice financing is only used in desperate situations, then you’re making it work for your business.

Professional Advice on Invoice Financing

Looking for professional advice on invoice financing? Ready to explore other forms of business funding? Download our free Guide to Business Funding and register to attend Business Funding Show ’16. At #BFS16 you’ll be able to join hundreds of entrepreneurs and finance providers and learn what funding option is best suited for your business.

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Do you have any experiences with invoice financing? Do you have more ideas about how to really make invoice financing work? Please leave a comment below or connect with us on Facebook or Twitter. We always love to share a good story!