A Guide to Factoring and Invoice Finance for SMEs

Even at the best of times cash flow can be a problem for Small and Medium Enterprises (SMEs).  But with the rise in VAT and the lock down on bank lending you may be finding it impossible to keep your head above the water.  The lag between the time that you outlay for stock and the date at which a customer pays for their purchase of that stock can stretch to months.  And this causes a direct threat to the growth, or even the survival, of your business.

However, one viable solution to this kind of cash squeeze is available through invoice financing.  This is when you use the strength of your sales ledger to access credit.  And it comes in two forms: invoice factoring and invoice discounting.

Invoice factoring is when you sell your invoices onto an invoice financing company.  Typically you will receive up to 90% of the value of these invoices within 24 hours.  The buying company then takes over control of your sales ledger and chases up the debts.  The percentage of profit lost in the handover of your invoices may seem disconcerting but if you take into account the cost of interest on an overdraft or a loan, along with the additional cost of employing a person, or your own time, to debt collect invoice factoring offers good value.

Invoice discounting is when you draw loans on the strength of your sales ledger.  In this case you retain control of your invoices and are still responsible for debt collection.  This may not save as much cash as invoice factoring – you have to pay the cost of chasing your own invoices – but for some companies discounting is a more attractive option as the use of third party in debt collection can interfere with customer relations.

There is also a third option, which is a development of invoice discounting, called selective invoice discounting.  This is when, instead of borrowing against the whole of your sales ledger, you borrow against specific invoices.  Because invoice financing incurs a charge for as long as the debt is uncollected selective discounting means that you can weed any invoices out of your portfolio that have the potential to be write offs.  And at the other end of the spectrum, you can choose not to borrow money against invoices that you know will be easy to collect.

Invoice financing may not be a good option to your business if you have a very narrow profit margin.  But for many SMEs it is difficult to secure a bank loan, or at least one without extortionate interest rates.  And in this situation invoice financing certainly pays.  Another benefit is that you do not have to worry about your own credit rating as it is the credit rating of your customers that is of interest.  It also means that you know when your cash is coming, while the increase in cash flow can encourage your business growth.  And as your business develops you can use invoice financing to gain credit that is related to the growth of your business.

It is important to understand exactly what you are entering into when you sign up for this kind of credit, and to make sure that it is the right choice for your business.   But if your SME is having problems with cash flow then invoice financing has the potential to be a great solution for you.

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