One of the primary issues facing all businesses, no matter what size, is cash flow. Most businesses must spend money to make money, which means they are using the companies cash flow to pay overheads or purchase inventory and typically cannot replace that money until a sale is made. If a business grows too fast, they may be spending more than they are bringing in which can potentially threaten the survival of the business.
If cash flow is a problem, a business should consider invoice financing.
Invoice Financing is a means of obtaining cash equivalent to what is owed on outstanding invoices before the customer pays needs to pay the invoice.
To attract new customers and be competitive in their market businesses are often forced to offer financing or credit plans. Offering this can provide a greater opportunity for their customers to make a purchase.
Invoice Finance works using a third-party financial institution for the business to borrow money based on the value of their outstanding invoices. The financial institution will pay the company a significant portion of the money owed on the invoice before the invoice is paid by the customer. The financial institution, paying the amount of the invoice, will either be responsible for collecting against the invoice or the company will pay back the financial institution when they receive payment for the invoice.
There are two primary methods of Invoice Financing – Invoice Factoring and Invoice Discounting.
Invoice Factoring is the more common form. The financial institution or factoring company will simply by the invoices from the business. They will then be responsible for collecting what is owed against the invoices. Once the customer pays the invoice, the factoring company takes out their commission or fee and then passes the remainder of the money collected to the business.
Confidential Invoice Discounting
Invoice discounting provides the business the ability to retain control over collecting the outstanding invoice payments. The discounting company provides the business a loan based on the amount owed in outstanding invoices. As customers pay their invoices, the company repays the loan with interest.
Which method is best?
Each of these types of invoice financing has disadvantages. The primary disadvantage to invoice factoring is the company gives up all rights to collecting on outstanding balances. This means the invoice factoring company is dealing directly with the business’ customers, therefore the business cannot control that process.
Using invoice discounting eliminates this issue, however money received through this process is a loan and interest must be paid on the amount borrowed until the loan is repaid.
Benefits of Each Method
It is generally quicker and easier to get invoice financing than it is to get a loan from a bank. Invoice financing is a way to quickly improve cash flow and to provide a cash injection into the operating funds of any business to help if a company is rapidly expanding. Each method should be carefully considered, and all the costs examined before making a decision. However, both methods are a good way to support an expanding business.