“It’s not sold until it’s paid for.” Does this phrase sound familiar? In B2B sales, the provision of credit and waiting for invoices to be paid is just part of day-to-day business. But wouldn’t it be nice to see that cash a little sooner? After all, it is money that is owed to your business. Cash tied up in the receivables ledger could fund business growth or other objectives, if it became accessible sooner.
And this is exactly where invoice finance comes in.
Invoice finance is a form of funding available to businesses that uses their unpaid invoices as security to borrow money from a lender. Invoice financing is offered via two main finance options: invoice factoring and invoice discounting.
Invoice finance is sometimes referred to as receivables finance, or receivables financing, and supports accounts receivable teams in accelerating cash flow. It can be thought of as the accounts receivable side of supply chain finance.
The advantage of using invoice financing over other types of business finance, such as overdrafts or business loans, is that the value of unpaid invoices is taken into account as an asset type. Consider invoice finance as an advance on the cash owed to your business; one that provides a greater degree of credit assurance to the lender and consequently reduces the finance cost.
How does invoice finance improve cash flow?
Cash flow is the lifeblood of every business. Without a steady inflow of cash to meet overheads and pay suppliers, businesses go out of business pretty quickly. Credit control strives to reign in the risk to cash flow through assessment of every new customer’s creditworthiness before credit is offered.
Invoice finance generates cash flow from the invoice value within a more predictable (typically, guaranteed) timeframe than relying on invoice payment within payment terms. Cash flow challenges are more prevalent than ever. The volume of late payments is rising globally, and 94 percent of Western European businesses have seen days sales outstanding (DSO) increase in the last year to an average of 98 days.
Neglecting to implement an invoice finance solution, or alternative solution such as Managed Accounts Receivable (more on this later), can leave your business’s cash flow at the mercy of customers making timely payment of outstanding invoices. The unpredictability of this approach undermines effective business planning.
What are the different types of invoice finance?
Invoice finance breaks down into two popular approaches: invoice discounting and invoice factoring. The difference between these types of finance lies in who takes ownership of the invoicing and collections process.
Both forms of invoice financing are facilitated by invoice finance companies that provide the invoice finance facility, but differ in whether they are directly connected with customers as part of the invoicing and collections process. There are pros and cons to both types of invoice finance, so read on for more detail on these, as well as alternatives to invoice financing, to help you decide which solution best fits your business needs.
What is invoice discounting?
Invoice discounting gets its name from the fact that the seller ends up essentially discounting their sales, because they received the total invoice value minus a fee. The invoice finance provider who advances the cash is paid a fee, based on the value of the invoice. Invoice discounting is borrowing that uses the receivable value as collateral.
The main steps in the process are:
- The seller sells to and invoices buyers as they normally would.
- A copy of each invoice is sent to the invoice finance provider.
- The invoice finance provider then forwards a percentage of the invoice value to the seller within a short timeframe.
- The seller is responsible for bringing the payment in on time, so there is no change to the collections process; the seller in still responsible for chasing payments.
- When the debtor pays, the remaining balance of the invoice is received by the seller, but a service fee is due to the invoice finance provider.
The simplicity of invoice discounting can be both a benefit and a drawback for borrowing as a route to liberate working capital.
What is invoice factoring?
Invoice factoring involves the seller selling their invoices to a third party (called a factor), who then owns the customer invoice and can collect the invoice amount directly from the customer.
With customer payments going directly to the factoring company, it is immediately apparent to customers that the seller has employed an invoice factoring company to assist with the accounts receivable process. This can leave a negative impression, implying that the seller is either struggling with cash flow or needs to raise working capital.
The main steps in this process are:
- The seller enters into an agreement with a factoring company, allowing them to manage their sales ledger and credit control for a fixed term (often 24 months).
- A percentage of the total invoice value is advanced to the seller each time an invoice is produced.
- Buyers adapt to changes in credit limits and collections process run by the factoring company.
- When the debtor pays the factoring company, the balance of the invoice is passed to the seller, minus a service fee.
Factoring is a far bigger commitment than invoice discounting but can significantly reduce the credit and collections workload and provide much needed access to working capital.
However, a word of warning, factoring without a non-recourse agreement can leave you open to repaying the funds that were provided by the factor if your customers default on payments.
Are there other variations on invoice financing?
Start-ups, small businesses, and SMEs may not want to engage an invoice finance provider to support their full sales ledger. In these cases, it may be more appropriate to consider selective invoice finance, such as spot factoring or selective invoice discounting.
Both of these solutions apply invoice financing work to specific invoices. You could apply the principles of invoice discounting or invoice factoring to specifically selected single, or multiple, invoices from the sales ledger.
However, this greater flexibility comes at a higher cost. Typically, businesses will only want to select higher risk invoices for financing; therefore, these solutions carry a higher premium than working with an invoice finance provider to borrow money against the entire sales ledger.
What are the alternatives to invoice financing?
Aside from using alternative funding sources to support cash flow, such as overdraft facilities or bank loans, there is an alternative to traditional invoice financing that provides many of the same benefits without the associated drawbacks.
Managed Accounts Receivable or ManagedAR from Corcentric provides the cash flow benefits and simplicity of invoice factoring without the perceived inconvenience of placing a third-party between you and your customers. Corcentric acts as an extension of your accounts receivable team, so that invoicing and chasing payments appears as normal to your customers. However, this is provided as a fully managed service, underpinned by AR automation technology used by Corcentric to process in excess of £197bn in invoice value for clients globally each year.
Because ManagedAR is a non-recourse service, providing bad debt protection against customer insolvency, there are no unexpected costs to pay at a later date.
Businesses typically use invoice finance to borrow with a lower interest rate than other funding options. A clear benefit with Corcentric ManagedAR is that, in addition to providing this funding, Corcentric also takes away the complexity, time and cost of sending, uploading or manually keying-in invoices to buyers’ online invoicing portals.
How best to leverage invoice finance
Leveraging invoice finance or ManagedAR can essentially turn the negatives of high DSO, and a large volume of outstanding invoices, into the working capital needed to drive business growth, provide stability, and guarantee cash flow certainty in uncertain times.
Lending via these routes will always be proportional to the total invoice value used as security for the loan. It’s important to remember that invoice finance and alternatives, such as ManagedAR, can provide an easier path to funding than traditional lending facilities, but are still under the purview of the financial conduct authority or FCA in the UK, and the Federal Reserve Board (FRB) in the US. The biggest gains will come from leveraging high volume and value of outstanding invoices to generate higher volumes of funding.
Learn more about how ManagedAR can provide cash flow certainty in a similar way to invoice factoring in our webinar, How to achieve your Cash Flow KPIs in 2022, with certainty.