Invoice financing is a method employed by companies to raise money against outstanding debts. Usually, a third party will purchase any invoices you have that remain unpaid, although the amount paid will be lower than the amount outstanding on the invoice.
There are two main types of invoice finance: invoice discounting and invoice factoring, which is also referred to as debt factoring.
Invoice factoring
A third party will buy your outstanding debts off you and collect the debts from clients themselves. Initially, they will make an agreed amount available to you, usually around 85%, and once the debt is completely collected, they will pay the remaining balance to you. You will pay a fee and interest for this service. However, the initial amount is paid directly to you and will be paid into the business funds straight away.
Pros and cons of invoice factoring
The financier will deal with the sales ledger and collection process on your behalf, so you can deal with other aspects of the business. However, you may want to check that the collection methods are suitable for your company. The financier will carry out credit checks on clients so that you are more likely to be dealing with clients who pay promptly. It’s crucial to check how the financier deals with the clients, as negative behaviour could impact on the brand. Clients may want to deal with you, as the company manager, which could have a negative impact on trade.
Invoice discounting
Here, the financier doesn’t become involved with the collection of debts or dealing with the sales ledger. Instead, the financier lends a percentage of the outstanding amount to you, in exchange for a fee. If clients pay you any money owed, the money is paid to the financier so that the amount you owe is reduced. As the balance you owe is reduced, you can borrow more for new invoices that are unpaid, as long as the amount doesn’t exceed the agreed percentage. Collection of debts remains your responsibility.
What are its pros and cons?
With this method you can still maintain contact with clients and they will be unaware that you have borrowed against their outstanding invoices. However, you will lose money on your orders as you have to pay a fee. This may not help you if you sell to the public, as most financiers will only deal with commercial invoices. Occasionally, these ‘book debts’ may be used as security when you apply for funding. If you have sold them to a financier, they will no longer be available as security.
If you want to know more about invoice financing, please call us to arrange a meeting.