Maintaining robust cash flow, navigating slow sales periods or capitalising on growth opportunities are several reasons why businesses might seek additional funding sources. These businesses will discover that there are many financial solutions available, and choosing the most suitable one can be daunting.
Invoice financing, also referred to as debtor finance, is a funding mechanism that allows companies to unlock capital tied up in their outstanding B2B invoices. It’s the ideal funding solution for businesses experiencing rapid expansion.
As a business owner, if you’ve started researching invoice financing no doubt you’ve encountered a range of terms, definitions and financial products, such as invoice funding, invoice factoring, and confidential and disclosed offerings. So, what is invoice financing, what are its benefits, and how can it serve your business? We explore these questions, uncovering the financial instruments available and their role in supporting businesses across various sectors.
How invoice finance works
Efficient cash flow is vital to establish, operate and grow a business. Solid cash flow allows a business owner to sustain operations during quiet periods and seize new opportunities to expand their offerings. It’s vital for business growth and to forge strong ties with suppliers and partners by ensuring timely payments.
However, cash flow can stagnate if you experience delays in customer payments. This is where invoice finance comes into play, providing immediate access to the capital bound in your company’s outstanding invoices.
Sam Ralton, Octet’s Director of Working Capital Solutions, explains. “There are several terms for these products. Invoice finance, receivables finance, debtor finance — they all cover the same broad offering, which considers the receivables ledger or the outstanding invoices, and facilitates funding against them.”
There are primarily two approaches to financing outstanding receivables and ensuring a consistent cash flow: invoice factoring and invoice discounting. Let’s delve deeper into these methods.
What is invoice factoring?
Invoice factoring is a form of invoice finance where you bring your B2B accounts receivable to a financing company. This financier then provides you with a substantial portion (typically up to 85%) of the invoices’ value immediately in exchange for a small fee.
The financing company takes over collecting and processing payments from your customers or clients. After the financier has recovered the amounts due, they will forward the remaining funds to the business, deducting a nominal service fee.
By transferring the debt collection task to a finance company, you may reduce administrative expenses and free up your team’s time. The drawback is having slightly less control over some operational interactions with your clients.
Factoring services often include the management of the sales ledger, such as allocating payments and issuing statements and reminders. As a result, the costs might be higher than other invoice finance services. It’s also apparent to your clients that a third-party financier is involved, as they will direct their payments to the financier.
Sam says you probably won’t hear the term ’factoring’ in contemporary finance as reputable finance providers like Octet offer more tailored invoice finance solutions and collaborative partnerships. “Invoice factoring used to be fairly intrusive. Businesses found they had to hand in every invoice, and the financier would chase up the debts.
“At Octet, we have finance relationship managers who are constantly collaborating with clients to identify cash flow issues or opportunities and assist with these.”
What is invoice discounting?
Invoice discounting is different from invoice factoring in one crucial aspect: debt collection remains your responsibility. Invoice discounting typically applies to the total ledger balance, rather than individual invoices. So, this approach can help even out cash flow variances throughout a given period.
This method allows you to retain the management of your sales ledger, so is more appealing to businesses that want to maintain control over this vital component of operations. As such, invoice discounting offers more confidentiality; your customers remain unaware of the financing arrangement with your financier.
Let’s further explore the differences between a confidential and disclosed facility.
Confidential and disclosed invoice finance: a comparison
A confidential invoice finance arrangement is one where your customers are unaware that a financing company is involved. Here are a few things to consider:
- There is no obligation to disclose to your customers — the debtors — that your business is using invoice finance, nor does the finance company generally contact them.
- Once your confidential facility is approved and established, you’ll inform your debtors of a change in bank details to a new account, which the financier manages on trust.
- You submit invoices to both the financier’s platform and your customers. The finance company advances up to 85% of the invoice amounts to you. Following your customers’ payments into the trust account, the finance company will send the remaining balance to you after deducting a service fee.
- This method allows you to continue your established accounts payable processes. While you retain the duty of managing payments, you also maintain full control over customer relationships.
Conversely, with disclosed invoice finance, all parties know and consent to the financing arrangement. Here are a few things to consider:
- Your invoices will inform your customers about the involvement of the third-party financier, who will also have the authority to pursue outstanding payments.
- With a disclosed facility, the finance company reaches out to your customers when an invoice is submitted. These customers will pay into a financier-managed trust account, knowing it is separate from your business’ account.
- You might have to pay higher fees for a disclosed facility due to the finance company’s increased involvement in implementing its own debt management strategies.
- Like the confidential method, you receive an advance of up to 85% of the total invoice value quickly. The finance company then takes on the role of coordinating with your customers to secure payment. When your customers fulfil the invoice, the finance company transfers the remaining funds to you, less their fees.
- This option also delegates the debt collection process to the financier and ensures transparency for everyone involved.
Choosing between confidential and disclosed
So, which is best for your business — confidential or disclosed financing? That depends on a couple of factors. Firstly, the strength of your business’ credit rating. A solid rating may qualify you for confidential options and the corresponding lower fees.
Secondly, your preference for control. Some businesses will want to retain direct management of debtor relations, while others prefer to outsource it.
As businesses become more comfortable with external management of their debt collections and customers become accustomed to third-party involvement, using a financier makes sense as a strategic cash flow decision. Leveraging one of your most significant assets — your receivables — can accelerate your business growth, benefiting you, your suppliers and your customers.
The advantages of invoice finance
Why opt for invoice finance instead of traditional financing methods like a bank loan? Sam weighs in.
“A significant limitation of traditional bank financing is that banks like ’bricks and mortar’ assets, often insisting on property collateral to back business loans,” he says. “The problem is, not all companies have ample property assets for collateral, nor are they inclined to risk the personal assets of their directors.
“Invoice finance, by contrast, uses what is frequently the company’s largest rolling asset — the accounts receivable ledger. This ledger represents the cash customers owe to the business and it typically lies dormant until the payment terms are met. An invoice finance agreement leverages this asset for funding, circumventing the need for property or other personal guarantees.”
Banks are also notoriously slow to respond to funding applications, with some finance approvals stretching beyond six months. This delay means businesses suffer even more cash flow challenges or forfeit opportunities. Invoice finance arrangements, however, can be authorised in a fraction of that time.
Is invoice finance right for you?
When evaluating an invoice finance option for your business, there are a few things worth considering:
- The associated costs will vary based on the financier, the specific product, the amount of management required by the financier and whether the arrangement is confidential or disclosed.
- “Typically, costs are the interest rate on the borrowed sum and a service fee,” explains Sam. “There might be more work in a disclosed invoice finance facility, as the financier regularly assesses the ledgers.”
- Sam adds that in his experience, the fees are only marginally higher than those of a conventional mortgage or overdraft.
- The appropriateness of invoice finance will depend on your business requirements. Sam says some businesses have had negative experiences with invoice finance, but this is generally because the financier or product was unsuitable in the specific circumstances.
- Apprehensive about relinquishing control of your ledger management to a financier? It’s a legitimate concern, so it’s even more important to partner with the right financier. Seek out an invoice finance company with a robust track record, advises Sam. “Trust in the stability of the financing company is crucial.”
- Sam cautions against using finance companies offering rapid solutions. “There are many out there providing short-term loans at steep interest rates. These are quick fixes and aren’t conducive to long-term business viability. Partner with a financier who is committed to supporting your long-term business vision.”
Is your business ready for an invoice finance solution?
Consider these questions:
- Due to your payment terms, is your business experiencing cash flow issues?
- Are you unable to restock until invoices are paid?
- Do you want faster-moving cash flow to ease the pressure?
- Are there growth opportunities you want to pursue but can’t until you sort out your cash flow?
- Do you contract with large corporations that set longer-than-average payment terms, leaving you with a shortfall?
- Are you unable, or don’t want, to provide security like property to access funding?
If you answer yes to any of these, it’s worth considering invoice finance for your business.
“Most businesses that speak to Octet about invoice finance have high supply costs,” says Sam, who gives the example of a Western Australia labour-hire company that experienced depleted cash flow after taking on new customers. Octet provided a $2 million invoice finance facility and the cash flow injection helped the company increase its revenue significantly.
A NSW-based labour-hire company was in a similar position. In just seven years it had grown from a startup to turning over $30 million. Its bank couldn’t support its finance needs and the business had to turn away new work. So it approached Octet for a $9 million invoice finance facility. This allowed it to keep taking on new customers while paying its invoices on time.
Invoice finance allows businesses in a growth stage to more easily fund their operation without having to wait for debtors to pay.
“These facilities grow with the business,” says Sam. “As you raise more invoices, you can generally access more funding.”
Octet, the invoice finance experts
Visit our Invoice Finance page to see how you could convert up to 85% of your unpaid invoices to cash within 24 hours. Use this cash to more quickly pay suppliers, buy equipment, invest in more stock or expand your business via staff growth or product and marketing innovation. The solution is fast and flexible — use it as your primary funding source, or only for top-up funds
Octet’s Invoice Finance is available to new businesses, growing companies or well-established enterprises. We like to see an annual turnover of at least $1 million, an outstanding invoice value of $100,000+, and some demonstrated business trading history. But feel free to get in touch if you’re growing fast and turning over $500,000 or more, as we may be able to assist.
When looking for an invoice finance solution for your business, partnering with a reliable financier is essential. Since 2008, we’ve offered a suite of working capital solutions, with Invoice Finance among our specialties. Connect with us today to explore how we can fuel the expansion of your business.
Disclaimer: These comments are only our views and should not be construed as advice. You should act using your own information and judgment. Although information has been obtained from and is based upon multiple sources the author believes to be reliable, we do not guarantee its accuracy, and it may be incomplete or condensed. All opinions and estimates constitute the author’s own judgment as at the date of publication and are subject to change without notice.
