Small and medium-sized businesses have numerous financing options in 2022, with invoice financing offering a relevant case in point and an increasingly popular choice.
According to research recently published by IGF, approximately 27% of businesses with a turnover of between £1 million and £500 million now use invoice financing, while this number is expected to increase markedly in the years to come.
But what exactly is invoice financing, and is it a good idea for your particular business? Let’s get into it!
What is Invoice Financing?
Broadly speaking, invoice financing is an accessible way for your business to borrow capital against the amounts owed by individual customers.
More specifically, firms will secure invoice finance by selling their accounts receivable to a third party entity, whether they select a single invoice from a particular client or leverage the total amount owed by customers to secure a larger amount of money.
The money is then extended by lenders for the duration of the invoice term, while creditors will utilize either factoring or invoice discounting to secure a return (we’ll touch more on these options a little later in the piece).
Either way, the total amount borrowed will be repaid once clients have settled their invoices, creating a short-term and manageable cycle of debt that can be highly beneficial in some instances.
What are the Two Main Types of Invoice Financing?
As we’ve already touched on, there are two main types of invoice financing. The first is invoice factoring, through which firms sell their accounts receivable to a commercial finance company for a percentage of the total value.
This is usually between 60% and 80% of the total amount leveraged, while the finance company in question then takes all responsibility for collecting the client payments, overseeing credit control, and processing paperwork.
There are clear pros and cons to this methodology, as while it eases your administrative burden it’s a little more costly than invoice discounting.
With this model, you’ll simply borrow a relevant amount of cash against the outstanding invoices, with the lender effectively ‘buying’ unpaid invoices and providing cash advance based on their total value. The lender then pays out the remaining balance after your clients settle their invoices, creating a quick and simple flow of cash into the business.
The Last Word – Is Invoice Financing Right for You?
Ultimately, you’ll need to remember that invoice financing is a method of borrowing capital. In this respect, it should only be considered as a manageable and short-term way of optimizing cash flow as a small business, rather than additional revenue.
Invoice financing is also effective in instances where you’re bound by 60 or 90-day invoice terms, which can significantly disrupt cash flow into the firm and make it hard to complete new business.
You should consider all of these factors when determining whether invoice financing is right for you, so that you can make an informed decision for your business.
