If your startup or SME has a revenue system based on invoicing it can be extremely frustrating. Waiting for your invoices to be paid – especially when customers default – can run down an otherwise viable business. The money you’ve extended as credit to your customers represents funds you can’t put back to work in your business right away, which ties up your working capital.
This is basically what invoice financing – aka accounts receivable financing – can do for your business. Invoice financing is not the best, cost-efficient way to finance your business operations. It tends to be expensive and so is perhaps not a long-term financing strategy. However, it can provide you with better cash flow predictability. Use invoice financing to ease the burden on your business if you’re running short of capital or urgently need to meet other expenses.
Once you agree to sell an invoice to the financing company, they generally will advance you about 85% of the total value of the invoice. The remaining 15% of the balance will be held in reserve. From this reserve amount, the financing company will collect their first fee (similar to a processing fee, it can be around 3%). The invoice financing company next charges a “factor fee” that will depend on the intervening time between the funds being granted and the invoice being paid. The fee is invariably calculated on a weekly basis. For example, a factor could charge 1% each week until the invoice is paid. Once your customer pays the invoice, you will receive the reserve amount, minus the total fees accumulated.
The above explanation is the norm, but there are invoice financing companies that will simply advance you 100% of an outstanding invoice. In this case. you’re required to reimburse weekly, with fees, over a set period of time – usually around 12 weeks – until the advance is fully paid off. This gives you an extra boost and is therefore slightly more costly. Also, this method does not regard whether your customers settle their debts or not.
There is an easy-to-read case study from Alternative Business Funding that illustrates what prompted one entrepreneur to opt into invoice financing.
Let’s say you have a £10,000 invoice with 30-day terms. An invoice financing company may immediately advance you 85% of that amount (£8,500), holding £1,500 in reserve. The customer then pays the invoice 2 weeks before the due date. After subtracting the 3% processing fee (£300), the invoice financing company would keep its factoring fee, which is 1% per week the invoice was outstanding (in this example that would be 2% or £200) and give you the remaining £1,000. In primitive terms, the invoice financing company sold you £9,500 at £10,000.
To many entrepreneurs invoice financing is a necessary evil. The problem is not that your business is failing. The problem is simply that you don’t yet have cash from a sale. It’s a shame to have to lose a portion of your potential revenue just because of that. Some things you can do to make invoice financing work for your business are: