Using invoice finance to solve business problems
Firstly lets cover the basics of invoice financing! What it is and who offers it?
What is invoice financing?
Invoice finance / invoice financing / debt factoring is a form of cashflow lending and is when a lender provides finance to a business, using their debtor book/ invoices as a form of security. Instead of a business waiting 30 to 90 days to be paid, a lender will provide upfront funds, typically 60% to 80% upfront of the invoice value. Then when the invoice is paid, the lender takes back their money plus interest, and gives the rest to the borrower.
Basically, an invoice financer is buying your invoices from you at a discount! Which means you get money today instead of in 90 days’ time. Invoice financing is just one form of finance, and one form of private lending that exisits.
Who offers debtor financing?
There are many players in the invoice financing market. Banks such as Westpac offer invoice financing, then you have second tiers (many who are funded by banks) and then there are third-tier private market invoice financiers, who have less stringent conditions.
Each tier has its advantages and disadvantages which we will cover in future articles.
When should debt factoring be used?
Typically, businesses will use invoice financing in the following scenarios
- They are rapidly growing.
- They have cashflow problems.
- They don’t meet bank criteria for a bank loan.
- They don’t wish to put a GSA on their business or take a mortgage against property
Fundamentally invoice financing is used to help add further capital to feed the growth of the business or to solve immediate cashflow problems.
Examples of debtor book finance
Imagine a business that is a subcontractor to a tier 1 builder for electrical contract work. Every month the subcontractor might do a $500k worth of work, however it takes the tier 1, 90 days to pay. During that 90 days the subcontractor has to pay for staff, pay suppliers for materials and general business expenses. If he has to pay his staff fortnightly, and if he has to pay his suppliers monthly, that 90 day period can significantly diminish his free cashflow.
Enter invoice financing! If he can get $400k of that invoice paid upfront, instead of waiting 90 days. He can pay his staff and suppliers on time and continue his business for the following months work. At the end of the 90 days, His $500k is paid by his client, and the lender deducts for example 3% of the amount for providing the facility. So the subcontractor gets the remaining $85k at 90 days, plus the $400k he got from day 1.
What problems does invoice financing solve?
One of the largest problems businesses have, is the time it takes for debtors to pay them and for them to have free cashflow to prepare for the next order. By getting invoices financed upfront ,this solves several cashflow issues. The beauty of this, is the business can then use those funds to pay staff and pay for supplies, for upcoming orders. This ensures the business is able to continue as BAU, and more importantly the business can grow!
How can you offset the costs of debtor financing?
Sophisticated business owners can use the funds they receive from invoice financing, to negotiate better terms with suppliers to get discounts on supplies!!! Additionally, they may negotiate with subcontractors that if they pay them earlier, they should be entitled to get a discount. By using this strategy, business owners can offset the cost of their invoice financing, by getting better terms for inputs into their products/ services! Talk about a win win!
