Invoice financing is the process of buying of your unpaid invoices by third party agents in exchange of some fees. Invoice financiers are professionals who can be independent or represent a bank or any other financial institution. There are broadly 2 categories of invoice financing – factoring and discounting of invoice. Here we closely look at both these forms of financing and evaluate the advantages and disadvantages associated.
Also known as debt-factoring, invoice factoring usually associates a financier who manages your sales accounts and collects unpaid money from your customers. This is a way through which customers would get to know that you are using invoice finance. When an invoice is raised, the financier buys the debt your customers owe to you and make a substantial share of the cost available to you upfront. Next, they would collect all the outstanding money from the customers directly and only then would they be able to make the residual payment to you. In return, you need to pay them any interest or fees associated.
Generally, large businesses or high profit firms which are experiencing rapid growth rates generally use such form of financing since they are in the need for additional funds to propel their growth. However, small business factoring invoice might not always be the right choice given that you might end up paying more money in interest charged lowering your profit making potential. This form of financing might curb your business growth if you use it in a business that is already working on a low to medium profit margin scale.
Discounting of Invoice
Here the financier does not manage your sales accounts books or collect debt on your behalf. This form of financing involves a financier to extend loans to you using your unpaid invoices as collateral. There is a fee that you would need to incur which is around some percentage of the total value of the loan.
As soon as the customer pays the money, it goes to the invoice financier which brings down the amount owed by you which in turn implies that you can borrow additional funds to raise more money for your business against invoices. This form of financing is done confidentially and generally customers are not able to find out if you have deployed such a practice.
Both kinds of financing accentuate cash flow. Moreover, you are free from hassles of managing sales ledger especially in invoice factoring, allowing you more time for focusing on business. Additionally, they can help in better negotiation with suppliers. The only downside is you are losing out on profits and it limits your potential to accrue other financing as well. Often invoice financiers work on commercial purchases, so you might be losing out on eligibility if your service line involves selling of goods and services only to public.