The Complete Guide To Invoice Finance

In this complete guide to invoice finance, we’ll show you the way to business success by explaining how invoice finance can help you to stabilise your cash flow and unlock working capital to support growth.

We will explain the different types of invoice finance; how to choose what best suits your business; how to qualify for funding and some of the tips and tricks you’ll need to successfully navigate your path.

Introduction

If you sell goods or services to other businesses there is a strong chance that you give your customers payment terms and wait 30, 60 or even 90 days for payment.

In this competitive world, long payment terms are more than just an expectation they are a necessity, but, they can devastate your cash flow particularly when you need a steady supply of funds to support your company’s growth.

We’ve been helping SME’s meet this challenge for over a decade by showing them how to unlock the cash hidden in their receivable’s ledgers.

The key is invoice finance. It is a very effective strategy for improving a company’s cash flow, but it comes in many guises.

Choosing the wrong option can be expensive.

What’s in a name?

Sometimes, companies advertise invoice finance as invoice factoring, debtor finance, invoice discounting, and receivables finance

At the end of the day, they are all basically the same: a business uses all or a portion of its receivable’s ledger as security for short-term loans. Any differences lie in the nuts and bolts of each facility and what each lender requires to set one up

How does invoice finance work?

Businesses can only use invoice finance for transactions with other businesses.

In its simplest terms, it works like this example:

Jerry’s company makes bicycle chains. Linda is his best customer. She installs the chains on her bicycles which she sells to the public.

The pair agree that Linda does not have to pay for the chains for 30 days.

It is a great deal.

Linda benefits because she has a month to sell her bicycles, take a profit and pay Jerry ‘s invoice.

Jerry benefits because a good customer remains loyal.

However, every now and again, Jerry’s cash flow becomes tight, so he asks an invoice finance company to buy the invoice he has issued to Linda .

The finance company will ask Jerry for a small discount on the face value of the invoice.

For example, if the invoice is worth $100.00, and the discount is 3%, Jerry receives $97.00 to help his cash flow.

When Linda pays the $100 she owes, the finance company recovers the $97 it advanced and earns a $3 profit.

Check out this video: How invoice finance works for more info.

Why do businesses use invoice finance?

Invoice finance provides a way for a business to manage cash flow when its clients take a long time to pay their invoices.

It ensures the business always has money in its account to pay its bills in a timely manner.

Failure to pay important suppliers, rent, utilities, staff and tax on time can cause serious reputational damage to a business and can invite creditors to take legal action which means the company’s credit rating suffers a severe hit or worse.

Why doesn’t Jerry ask Linda to pay sooner?

Jerry has offered Linda 30-day terms to keep her away from his competitors. He worries that if he insists on earlier payment, she will start shopping around, and he could lose a good customer.

Why not offer Linda a discount if she pays sooner?

Jerry knows that offering discounts to clients can backfire because they come to expect them with every transaction. He doesn’t want to give discounts to customers unless he has a good reason. By using a finance company he can pick and choose when he wants to discount.

What type of invoice finance facility should I choose?

There are two broad types of invoice finance products and the one you choose will depend on your cash flow requirements. One is single invoice finance, the other whole-of-book invoice financing.

What is single invoice finance?

Single invoice finance, also called selective invoice finance, is very flexible.

It allows you to pick and choose which of your sales invoices you want to sell to the finance company.

You can raise funds using a single invoice or multiple invoices. You can come and go as you please.

In most instances, there is no lock in contract requiring you to continue selling sales invoices for a certain period.

Many clients will set up an account and use it only when the need arises with weeks and even months between transactions.

Finance companies primarily rely on the quality of the financed invoice and the strength of the customer’s business to approve funds.

What is whole-of-book financing?

This traditional form of invoice finance, commonly called factoring in the past, involves a lender advancing funds against a company’s entire debtor’s ledger (receivables ledger) as security for funds for an agreed period, of at least 12 months with an automatic renewal.

Companies that consistently require access to significant amounts of cash to keep their operations running smoothly use whole-of-book facilities.

The financier will lend a percentage of the debtor’s ledger at any given time and keep track of all customers, payments and bad debts to ensure you always have enough money coming in to repay the funds and keep the client afloat.

Because monitoring creates costs, the finance company will often require its customers to sign a long-term agreement.

How much does invoice finance cost?

Let’s deal with the big picture first.

Single invoice finance and whole-of-book finance operate quite differently and pricing comparisons between the two are pointless.

The thing to remember is that there are no standard fees.  Pricing between companies varies widely depending on the services provided.

For example, some lenders offer a total credit control function, others do not. The former will attract higher fees.

When determining your fees, a lender will consider the risk to its capital and that often boils down to perception. One may consider transactions in a particular industry a higher risk while another lender may not.

Single Invoice Finance Costs

if you choose single invoice finance, the lender will require you to discount each invoice it buys depending on how long it will take to get its money back.

It’s not uncommon for financiers to ask for discounts of between 3% – 5% for a thirty-day payment period.

If payment takes longer the discount will be higher.

Some companies may reduce discount, in exchange for an application fee and a processing fee for each transaction.

Businesses generally use single invoice finance to meet short-term needs such as to pay unexpected bills or quickly boost cash flow to seize a new business opportunity.

Five key features of single invoice finance

  • Selective Financing: Allows businesses to finance specific invoices, giving them control over which invoices to include.
  • Flexibility: Provides flexibility in choosing which invoices to finance, meaning businesses can choose when and how much they want to borrow.
  • Fast Access to Funds: Offers quick access to cash by allowing businesses to finance individual invoices on an as-needed basis.
  • Lower Cost: Generally costs less than whole-of-book factoring as it focuses on financing individual invoices instead of the entire accounts receivable ledger.
  • Minimal Commitment: Allows businesses to finance invoices without a long-term commitment, providing them with short-term financing options.

Whole-of-book costs

A whole-of-book facility integrates into your daily business operations, meaning your accounts department and the lender will be in regular contact. The lender’s representative will oversee the debtors’ ledger and manage it. This results in the following potential fees:

  • Application Fee – covering the cost of a thorough examination of your business by the lender before approving the facility and any payments to a broker or introducer.
  • Management Fee – an annual fee based on the facility size, paid monthly irrespective of your usage of the facility.
  • Interest rate – applied to drawn funds on an annualized basis.
  • Discount fee – the lender retains this.
  • Transaction fee – a small fee per invoice to cover transaction costs.
  • Exit fee – Businesses must exercise careful management when exiting a whole book facility (see below)

Five key features of a whole-of-book facility

  • Comprehensive Financing: Provides financing for the entire accounts receivable ledger, offering a comprehensive solution for improving cash flow.
  • Credit Management: Includes credit management services where the lender manages credit control and collection of accounts receivable, relieving the business of these tasks.
  • Fixed Financing: Offers a fixed amount of financing based on the entire accounts receivable ledger, providing stability in cash flow planning.
  • Long-term Relationship: Involves a longer-term relationship between the business and the lender, as it encompasses the entire book of invoices.
  • Administration and Collection: Involves the lender handling administrative tasks and collections, allowing the business to focus on other aspects of operations.

Whole-of-book financing works best when a business is efficient and there are few disputes. If sales decrease or the number of your debtors falls away the lender may unilaterally reduce the funds available to you.

What security will the lender require?

Whole-of-book lenders will require control over the bank account that your customers pay into.  

If you are using single invoice finance, the lender may simply require that your customer pay the invoice into its account.

To protect their funds, lenders will almost always place a charge over your company’s sales ledger (accounts) and, in many instances, register a charge over all the assets of your business.

If another lender has a charge over the company’s assets, the invoice finance company will most probably ask the other lender to release the debtor’s ledger from that charge.

If your company’s tangible assets are strong, the lender may not require a personal guarantee. However, for smaller businesses, the it will most likely seek a company guarantee and personal guarantees.

If the invoice finance company deems that advancing funds to you carries risk, it may require property security.

What if a customer doesn’t pay an invoice?

You are always responsible for repaying the debt if a customer doesn’t pay.

Will the invoice finance company chase my debtors?

Some will, some won’t.

It depends on the type of facility you have.

If you are using single invoice finance, the lender will expect you to do the chasing.

If you have a whole-of-book facility, it will depend on whether you have a disclosed or undisclosed agreement (see below).

Essentially, those which offer disclosed facilities will chase debtors.

What is the difference between a disclosed and undisclosed facility?

A disclosed facility means that you have an agreement with an invoice finance provider, and they may contact your customers to verify invoices and arrange payment into the correct account.

Your invoices may include the finance provider’s bank details.

While some clients fear that this will send the wrong signal to a customer, it’s worth considering that this is a $65 billion industry. Most businesses are aware of invoice finance and accept it as a widely used form of raising capital for a business.

Obviously, an undisclosed facility means your customer is unaware that a finance company is involved. The customer simply pays the money it owes into an account in your name, but which is under the control of the lender. An undisclosed facility is likely to attract higher fees because it is the riskiest of the two.

Can I insure against payment default?

Most invoice finance providers will encourage you to obtain trade insurance to cover losses caused by defaulting customers.

Trade credit insurance will add to your costs but think of it as a fire extinguisher. You never want to use one, but if fire breaks out it could save you from a lot of tears.

Money from a trade insurance claim goes to your finance provider and it will only cover a portion of the unpaid amount – around 80 per cent. The lender will still expect you to cover its fees.

What are concentration limits?

Concentration limits are not so important if you have a single invoice finance facility.

They play a far more prominant role in whole-of-book arrangements.

A concentration limit represents how much a lender will advance against a company’s entire receivable’s ledger and is used to manage risk for both the lender and the business. The idea is to ensure that the business’s cash flow is not overly reliant on just one or two customers, and that the lender’s exposure is controlled.

Let’s say a company has 10 customers with an overall concentration limit of 80%. In other words, the lender will fund up to 80% of all invoices which are yet to be paid.

If two customers stop buying and invoice values decline, the company and the lender will review the concentration limit because the remaining customers’ invoices might now make up a higher percentage of the total accounts receivable.

In this scenario, the lender will most likey reduce the amount it will fund against invoices from the remaining customers. The company might also need to seek alternative financing or take steps to diversify its customer base to mitigate the impact of the two customers’ decline in business.

How do I end an invoice finance facility?

It should be easy to walk away if you have been using single invoice finance.

You can move on without any further obligation when the finance company receives payment for the last invoice it funded.

The exception might be if you have used a funder who charges an annual fee.  You could lose that amount.  Ask about this before signing on, indeed always read the terms and conditions to clarify your obligations before signing an agreement.   

Ending a whole-of-book facility requires some planning.

Finance companies generally ask for up to 90 days’ notice.

When you give notice, they will start reducing the number of invoices they will provide funds against. The closer to the end date, the fewer invoices they will fund.

Unless you have another source of working capital, this may leave you in a big hole during the last weeks of the finance contract.   

One way to avoid this is to ask a company which offers single invoice finance to pay out the debt to your whole-of-book provider which then transfers the liability to the new lender.  When all invoices are finally paid by your customers you should be able to end the single invoice agreement and reassess you next move without cost.

What do I need to apply for invoice finance

Financial documents which paint a positive outlook for your business will go a long way to comforting a lender and ensure you are approved for funding.

Pull your documents together before you start your search. Ask your accountant or bookkeeper to help and give thanks for the invention of online accounting software!

Some lenders want a lot of information, others less.

Documents

  • Interim financial statements.
  • Statements of the personal assets and liabilities of directors
  • The end of year Balance Sheet and Profit and Loss Report – up to two years.
  • BAS statements for the preceding 3 quarters
  • Cashflow projections or at least a budget
  • Most recent tax office consolidated accounts report – ask your accountant for
  • help with this.
  • Current bank balance and transactions for the preceding 90 days.
  • Up to date aged debtors listing
  • Up to date aged creditors listing
  • A copy of the Trust Deed if a trust is involved.

Startups often lack a lot of this information, but don’t let that rule you out. The following documents will also help:

  • A copy of invoices showing the amounts owed, the name of the customer and the payment dates. It’s not a good sign if an invoice is overdue.
  • Proof of delivery – including dockets, emails, payment schedules or anything that shows that your customer has received the product or service you provide.
  • Terms and conditions of sale to check if there are any conditions which could reduce the final amount paid by your customer.

Every lender has a drawer full of formulas and ratios that will be applied to your paperwork to answer 5 key questions:

  • Is the business growing and how?
  • Is the profit adequate and sustainable?
  • Is the business generating enough cash?
  • Are the company’s current finance arrangements sensibly structured

Conclusion

The clear advantage of using an invoice finance provider is that you obtain cash for your business very quickly.

It’s available as soon as an invoice is issued and can be used to grow your business, buy more stock or pay wages.

Invoice finance helps to overcome the challenge of customers who demand long payment terms.

It can smooth your cash flow if your work is seasonal and save you from large unforeseen expenses.

Invoice finance also opens the door to bigger and more lucrative projects which poor cash flow might normally prevent you from doing.

Unlike traditional term loans which require you to jump through hoops every time you apply to increase a loan. the funds that are made available with invoice finance should automatically increase as your sales increase. You’ll find further supporting information on this Wikipedia page.



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