Invoice finance is widely available around the world. Invoice finance is offered by banks as well as specialised factoring companies. In essence, invoice finance involves a company using an unpaid invoice from a customer to secure the cash quickly, rather than having to wait 30, 60 or 90 days for payment. Invoice finance is also known as ‘factoring’, ‘receivables finance’ and ‘accounts receivable factoring’.
Factoring companies pay up to 90% of the value of an unpaid invoice in a couple of days. They then wait until the due date is reached on the invoice. The factoring company is paid directly by the debtor. The factoring company deducts its fees and remits the remaining money to the original holder of the invoice. The process can be done rapidly, especially if a company regularly uses the same invoice finance company.
In contrast, securing a bank loan can be a long, drawn-out process. For bigger companies that have already secured a line of credit, this is not true. However, for small and new businesses being accepted for a bank loan can be a headache. The bank will want to see financial records and other documentation. For a company that has only been trading for a year it might be impossible to satisfy the bank’s criteria for a loan.
Putting aside the issue of whether a small company can even secure a bank loan, here are some reasons why invoice finance is better:
1. Invoice Finance is Quick and Convenient
Invoice finance can be organised and implemented in a matter of hours. The factoring company just has to confirm that the invoice is genuine and that payment will be re-directed to them. Once done, the cash can be released. Immediately, cash flow is improved.
In contrast, a bank requires lengthy forms to be filled in and documentation to be submitted. Sometimes, an interview is required. Once the bank has all the documents it needs, it might still delay making a decision on granting a loan. It is not easy or convenient if your company desperately needs cash to pay bills and suppliers.
2. End of Cash Flow Problems
Your company might be struggling to pay bills and find enough money to maintain production. Halting production until an invoice is paid makes no business sense.
Instead, a company with cash flow problems can choose which of its invoices it wishes to factor. Within a day, those invoices can be converted to cash sitting in the company account ready to inject vital liquidity into the company operation to keep production going at capacity.
Taking out a bank loan is a different proposition. As discussed, the delay in getting a decision can be detrimental to business. Moreover, a bank might seek collateral against a loan. This means potentially going into further debt, losing equipment or commercial property if for any reason the bank loan cannot be repaid on time.
Factoring companies are experts in securing payments for invoices. They have dedicated legal teams that are quick to respond to a late payment, and that are prepared to use legal recourse if necessary. Small companies might not have such in house resources to deal with slow paying customers.
3. No Caps
A bank will place a limit on a loan or a credit line. The cap cannot be exceeded without authorisation from the bank. That involves further delay, and the answer might be that the bank is unwilling to lend any more money.
In such a situation a company might be left unable to pay for wages or electricity. Even worse, a company might have received a massive order and without sufficient working capital might be unable to fulfil the order. Invoice finance is the simple solution – the invoice for the massive order can be factored to release the necessary funds to complete the order. Such a moment can make or break a company. Banks with caps or limits on borrowing could well break a company in the scenario described above.
While a bank loan is cheaper than a factoring service if you look just at the cost of borrowing versus factoring fees, if you zoom out the opposite is the case. A factoring company will do a credit check on your customers, decide credit limits, chase up late paying customers as well as do invoice processing. These are all extra services that should be included in the factoring fee. These extra services spare your own company resources and allow you to focus on your core business.
When all the services that an invoice finance company offers are added up it more than compensates for the factoring fee being more than the interest rate on a loan. Moreover, as interest rates continue to rise during the conflict in Ukraine, bank loans are becoming more expensive than before.
Because there is a delay period between applying for a bank loan and receiving a decision from the bank, a company is hampered. It is difficult to grab an opportunity that arises if a potential client has to be kept on hold while a bank deliberates. By using invoice finance a company has greater flexibility to seize business chances.
Not only that, but a company can take on orders that they might previously have struggled to fill because they are able to secure the cash necessary to hire new staff and lease more equipment using unpaid invoices or accounts receivable.
Accounts receivables financing might appear to cost more than bank borrowing but factoring companies more than make up for the extra cost with expert services. Moreover, factoring is quick and flexible. Waiting to hear back from a bank about a loan can be like being stranded on a desert island – you don’t know when or if you will be ‘rescued’. Factoring firms just need to check the legitimacy of an invoice and the credit worthiness of the debtor to make a decision. Thanks to the digital world that we live in, that can be done in a matter of hours.
Finally, a factoring company holds the invoice as security against non-payment. That is preferable to a bank requiring loans to be backed by assets.