What is Invoice Finance?
Invoice Finance is a funding solution that enables businesses to use their outstanding invoices to access an immediate cash flow boost.
Extended payment terms and slow-paying clients often result in a cash flow gap for businesses that provide net terms to their customers. This is a significant issue for businesses in Australia.
In our SME Growth Index Insight Series – Rebounding from COVID-19: towards 2021, we asked SMEs to name the top three factors that would help the small business sector rebound from the COVID-19 recession.
Federal Government legislation on 30-day payment terms was the second most popular factor, named by over 46% of small businesses.
Invoice finance is a way for businesses to overcome these issues and fuel growth with predictable cash flow, rather than worrying about working capital and chasing unpaid invoices.
How Invoice Finance Works
When you sell goods or complete work for another business, they will typically have 30 days or more to settle your invoice. You have paid out for staff, supplies, and materials to complete the order, but you won’t receive payment to cover your outlay for a month or more causing a cash flow gap.
Invoice Finance helps you to bridge cash flow gaps. You can access up to 95% of the invoice value upfront, with the remaining balance less fees released once your customer has paid.
Here’s how Invoice Finance works in 5 simple steps:
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You fulfil the order and invoice your client as usual.
- You submit the invoice to the finance provider.
- The finance company advances up to 95% of the outstanding invoice value to your bank account.
- Depending on the type of arrangement, the finance company handles the invoice collection, or you collect payment from your customer as usual.
- You receive the remaining balance of the invoice less fees.
- Invoice finance is a flexible funding solution and can involve a single invoice or your entire accounts receivable.
Invoice Finance in Australia
The use of invoice finance in Australia is increasing but is still relatively unknown and underutilised compared to our international peers.
Invoice finance volumes total 3.9% of GDP in Australia, compared to 19% of GDP in the UK.
This is despite Australian businesses suffering from amongst the highest rates of late payments in the world. According to the ASBFEO, Australian companies are paid 26.4 days late on average compared to 5.85 days late in the UK and 7.1 days late in the US.
Types of Invoice Finance
There are many different invoice finance funding options, but all of these solutions fall into two categories: factoring and discounting.
Invoice Factoring
Invoice factoring typically involves the sale of the accounts receivable ledger or selected invoices. You can receive up to 95% of the outstanding invoice value as an advance, with the remaining balance less fees transferred after collection.
With invoice factoring, the finance company is responsible for collecting on the outstanding invoices. Your customers will usually be aware of your relationship with the finance company.
Invoice Discounting
Invoice discounting allows a business to access a line of credit using its accounts receivable as collateral. You can access up to 85% of the value of your outstanding invoices upfront, with the balance less fees released once payment has been collected.
With this type of funding facility, you retain the responsibility for collecting on unpaid invoices. This can be beneficial if you have a dedicated accounts and collections department, or if you want your relationship with the finance company to remain confidential.
Selective Invoice Finance
Selective invoice finance allows you to arrange financing for a selection or single invoice, rather than your entire accounts receivable. Also known as spot factoring, this type of invoice finance can be beneficial for businesses with a smaller volume of high-value invoices.
You can turn your selected unpaid invoices into an immediate cash flow injection to help you pay suppliers, cover of overheads, and fund operations to fulfil new orders.
How Much Does Invoice Financing Cost?
The cost of invoice finance depends on the type of facility, and the risk involved for the finance company. Several factors can influence the costs of financing an invoice, including:
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The creditworthiness of your customers
- Your industry
- The number of invoices you want to finance
- The length of the funding facility
Generally, invoice discounting is cheaper than invoice factoring. This is due to the additional account management and collection services associated with factoring. You will typically pay more for a longer funding facility, with net-30-day invoices costing less to finance than a net-90 day invoice.
The Pros and Cons of Invoice Finance
Invoice finance is more accessible and flexible than a traditional business loan or credit card, but it has pros and cons you should be aware of before you apply for funding.
Pro – Fast Cash Injection
The most significant advantage is the ability to improve cash flow quickly. With increased working capital, you can be in a better position to negotiate bulk discounts with suppliers, reinvest in your business, and capitalise on opportunities.
Pro – No Ongoing Repayments
You can quickly raise funds without worrying how repayments will impact your working capital at a later date.
Pro – No Need to Use Your Home as Security
Unlike a business loan, you don’t need to use your home or personal assets as collateral to access funding.
Pro – Predictable Working Capital
You can be confident in your decision making with the knowledge that you have enough working capital to take on new staff, purchase new equipment, and support your business growth.
Pro – Flexible Funding
Instead of loading long term debt onto your business, you can tailor invoice finance to your needs with no minimum term contract. You can use the facility as a flexible line of credit that grows in-line with your business.
Con – Limited to the Value of Invoices
You can only secure funding up to the value of your accounts receivable. If you need a large lump sum for significant business purchase, equipment finance or asset finance may be a more suitable solution.
Con – Cost
An invoice finance facility will take up some of your sales invoice profit margin. You can use a cash flow forecast to ensure that improved cash flow will offset the invoice finance facility’s cost.
You can read our guide on how to create a cash flow forecast here.
What Happens if My Customer Doesn’t Pay the Invoice?
It depends on the terms of your funding arrangement. In most cases, you will be responsible for the costs of any bad debt. The finance company will carry out due diligence before approving an invoice for funding to minimise the risk of non-payment.
You can also use Bad Debt Protection to safeguard your business from the risks of customer non-payment.
Is Invoice Finance Suitable for a Small Business?
A short trading history or low credit rating can often mean that traditional business funding sources are out of reach for many small businesses and start ups.
Invoice finance is a much more accessible source of funding that is well suited to smaller businesses. The finance company will primarily look at your customer’s credit rating and ability to pay. If you’re a small business supplying a larger business on net terms, invoice finance can be a great way to plug cash flow gaps between payments and keep your business growing.
Is Invoice Finance Right for Your Business?
If your business offers net terms to your customers, this funding type may be right for you. It’s a fast source of financing that can help you manage your working capital during cash flow gaps and fund expansion during busy periods of growth.
By using your improved cash flow to reinvest and generate more profit than the funding facility’s cost, an invoice finance solution can fuel sustainable growth and help you to become more profitable.
ScotPac Invoice Finance
ScotPac Invoice Finance helps you turn your outstanding invoices into immediate funding. You can arrange a facility within 24 hours, with our dedicated team of relationship managers and decision-makers working with you to put the funding you need in place.
We’re growth enablers and put the needs of our clients at the centre of what we do. On average, our clients grow 3x faster than the Australian business.
If you want to find out more about a confidential invoice discounting arrangement or an end-to-end factoring service, speak to one of our friendly invoice finance advisors today.