Handling cash flow is often one of the most difficult aspects of running a business. Naturally, suppliers want to be paid on time, but unfortunately it's all too common for customers to delay payment, especially if they're a larger business with more power and influence. It can take a lot of valuable time and effort to ensure that issued invoices are properly paid, resources which could be better used to grow the business instead.
Luckily, there's a good solution to this problem. Invoice factoring is a financial service that allows you to realize the value of the invoices you issue, regardless of whether they've yet been paid.
How Does Invoice Factoring Work?
An invoice-factoring service effectively outsources the management of your business's cash flow and credit control. When you sign up, you begin to sell all your invoices on to the factoring company rather than the actual customer, and they will assume responsibility for collection of the debt. This in itself is a valuable service for many small businesses, but there is one crucial additional benefit. In exchange for a fee, you will be paid up to 90 percent of the invoice value within hours of issuing it.
Clearly, this can provide valuable benefits. It greatly streamlines cash flow and simplifies financial planning, and removes a layer of administrative complexity from your operation. Further, the invoice-factoring agency will tend to have more financial clout and be able to collect payments more efficiently, greatly reducing the chances of bad debt.
However, there are downsides. The most obvious one is that you'll be charged a fee for every invoice you issue. Whether this is a price worth paying depends largely on how many invoices you generate, how much of your resources you need to spend on collection, and how troublesome your cash-flow problems are.
A second drawback is that using invoice factoring can count against your company's ability to raise finance, as the factored invoices are classed as liabilities rather than assets on your balance sheet. Lastly, using an invoice-factoring service risks tarnishing your company's image. You have little control over how aggressively invoices may be pursued, and will be relinquishing at least some level of control over relations with your customers.
Invoice Factoring or Invoice Discounting?
Invoice discounting, also known as invoice financing, is a similar concept to factoring, in that it allows a business access to the value of an invoice before it has been paid. However, discounting is a much simpler product, being a form of short-term borrowing using the invoice debt as security. The responsibility for collection and management of the invoices will remain with your company, and not be outsourced. For smaller businesses without the resources to set up a full finance department, factoring is usually the best all-round solution.
Invoice factoring is a potentially useful service provided by many banks and insurers, and your financial or business adviser will be able to source a reputable company. If you want to improve cash flow and reduce the amount of resources you devote to credit management, then it's a solution that's certainly worth investigating.