If your business has a high level of debt owing you may struggle with cash-flow. If customers are slow to pay you may find it difficult to pay your suppliers on time. A lack of cash coming into your business, not to mention falling out with your suppliers, could spell trouble for your business.
Invoice financing is one possible solution. This is where a third party, often a bank or financial institution, agrees to buy your unpaid invoices for a fee. There are 2 types of invoice financing.
‘Factoring’ – also known as ‘debt factoring’ – usually involves an invoice financier managing your sales ledger and collecting the money owed by customers themselves. This means your customers will know you’re using invoice finance.
How does it work?
When you raise an invoice, the invoice financier will ‘buy’ the debt owed to you by your customer. They forward a percentage of the invoice (usually around 85%) upfront. They then collect the full amount directly from your customer. Once they’ve received the money from your customer, they make the remaining balance available to you after deducting their interest and fees.
You’re owed £40,000 by a customer. You sell the invoice to an invoice financier for £34,000 (85%). They collect £40,000 from your customer and pay you the remaining £6,000 when they receive the money. You pay them interest and any fees you owe.
A major advantage of factoring, besides better cash-flow is the invoice financier will look after your sales ledger and credit check potential customers meaning you are likely to trade with customers that pay on time. This frees up your time to manage your business. On the flip side your customers may prefer to deal with you directly and it may affect what your customers think of you if the invoice financier deals with them badly
With ‘invoice discounting’, the invoice financier won’t manage your sales ledger or collect debts on your behalf. Instead, they lend you money against your unpaid invoices – this is usually an agreed percentage of their total value. You’ll have to pay them a fee.
As your customers pay their invoices, the money goes to the invoice financier. This reduces the amount you owe, which means you can then borrow more money on invoices from new sales up to the percentage you originally agreed.
You’ll still be responsible for collecting debts if you use invoice discounting, but it can be arranged confidentially so your customers won’t find out. However, invoice financiers will usually only buy commercial invoices – if you sell to the public you might not be eligible.
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