Advantages and disadvantages of invoice financing
Invoice financing has been done for a long time. It is a form of asset-based financing to improve cash flow, pay employees and suppliers and invest in growth earlier than you could if you have to wait until your customers pay the invoices. But how does that work? Invoice financing is a way to borrow money against the value of unpaid invoices. You give something of value as collateral, in this case the invoices. The best known form of invoice financing is factoring. With this, you usually hand over your invoices directly and get paid immediately. Of course after deducting costs. These costs consist of interest, a risk premium and profit. In this article I describe the advantages and disadvantages of invoice financing. Incidentally, it is not useful for everyone. So let me start with that.
Who is invoice financing interesting for?
Invoice finance can help you to reinvest and grow your business, because you do not have to wait for your customers to pay the outstanding invoices. Your DSO will improve considerably giving your cashflow a boost. It can be beneficial for both large and small companies, but there are a few things to keep in mind when deciding whether this is right for your business.
Companies that send invoices with long payment terms are more likely to benefit from this form of financing. Then, if the turnover rate of money is high it becomes even more interesting. Take a temporary employment agency, for example. If a temporary employment agency pays its temporary workers every week and sends an invoice once a month with a 30-day payment term it very often needs liquidity. If this company is also growing you can calculate that there is always a need for additional financing. In this example, there is a logical connection between the challenge they have within the company and financing their invoices.
The advantages of invoice financing
When you need money to finance growth or an investment it is always nice to be able to come up with collateral. This removes risk from the lender. This can result in a higher financed amount and a lower interest rate. In principle, invoice financing has a clear head and tail. After all, an invoice is paid after 40 days on average. It is therefore usually convenient to let invoice financing be a continuous process, whereby new invoices are also introduced and financed. As the flow of invoices grows, so does your financed amount. And that in turn supports you in further growth. Here are three advantages of invoice financing:
- Maintain a stable cash flow and grow your business
In order to grow your business, you need a steady cash flow. Factoring is a good way to achieve this. Instead of chasing debtors you can focus on acquiring new customers, paying your suppliers in order to avoid supply chain constraints, and hire new employees.
- Improve customer relationships
Collection can be one of those tasks that gives you a terrible headache. Calling customers, sending emails and reminders. By financing your outstanding invoices, you’ll be unburdened from these time-consuming tasks. This gives you the opportunity to focus on the other aspects of your business, including building good relationships with your customers.
- Get your money quickly
Factoring can be set up usually within a week or two. This allows you to respond quickly to a cash flow shortfall and fund other business expenses, for example the payment of wages.
The disadvantages of invoice financing
There are also some disadvantages to invoice financing. It is often quite complicated to organise. You have to hand in a lot of forms. The purpose of those documents is to assess the risks and exclude as many as possible from the financing. If, for example, you send invoices outside the EU, they are considered more risky. In that case, a deduction will be made from the amount that can be financed. The stability of your organisation is also taken into account.
Another frequently heard disadvantage of invoice financing is that it is expensive. Factoring in particular is an area where there is a lot of supply from private equity organisations. And these organisations have hefty profit targets. Ultimately, supply and demand just come together here. An organisation that wants to grow faster and a financing provider that wants to make a return on capital.
If you need financing, there are many options. Be well-informed and get quotes from several parties. My advice is always to first make an analysis of your exact needs, your own strengths and weaknesses. Where is the value of your company? What do you have to contribute?
For years, Payt has been offering its clients financing based on outstanding invoices. For this, we work with Floryn and New10. These organisations only offer financing in the Netherlands. Are you also interested in a modern form of invoice financing? Then please get in touch with us.
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