Small and medium-sized enterprises (SMEs) are typically more dependent on external funding, particularly short-term funds, in the first years of their business as they navigate uncharted territory.
Cash flow issues are common because the owner usually hasn’t built up sufficient reserves and a solid enough revenue base to tide the company over financial setbacks and challenging market conditions.
Fortunately, companies have access to a much more extensive range of different sources of finance than in the past when bank loans were the traditional go-to source of funding.
Invoice financing has become a popular source of alternative funding to avert short-term cash flow issues. SMEs are highly reliant on the customers paying as quickly and reliably as possible because cashflow is key to their survival in the first couple of years. However, repayment terms vary depending on the nature of the customers. Some customers demand due dates anything from 60 to 90 days after delivery.
Small businesses are also at the mercy of late payers. In June this year, Xero released research that estimates that late payment by large companies to SMEs amounts to $115bn a year in Australia and that their payments arrived an average of 23 days after they were due. Without access to funding to tide them over, this could be the death knell for a growing business.
Invoice financing helps SMEs navigate these challenges by offering companies flexibility and quicker access to funds than traditional bank financing to supplement cash flows.
For these reasons and many others, SMEs are opting to set up funding contracts with invoice finance companies rather than tapping the traditional secured and unsecured bank loans that were the primary source of financial support in the past.
The benefits of invoice financing include the following:
Customer – Not Company – Track Record Comes Under Scrutiny
Companies seeking invoice financing do not have to prove they have a track record of healthy cash flows of profits. Instead, the invoice finance company makes a funding decision based on the credit history and financial strength of the customers who are responsible for paying the invoices. Banks, in contrast, will need to see evidence that the company is well capitalised and profitable.
A company Balance Sheet is Unencumbered
Invoice finance is not reflected as debt on the balance sheet of the company, whereas a bank loan becomes a liability. Thus, making use of invoice financing does not negatively influence the state of the company’s balance sheet. Instead, it turns assets on the balance sheet into working capital.
Less Administratively Intense and Time-Consuming
Applying for a bank loan is usually time-consuming and requires more documentation than invoice financing. An ongoing invoice factoring contract requires one legal document upfront that sets the conditions of the financing arrangement. This process usually happens in a matter of days versus the lengthy turnaround time of applying and being approved for a loan.
Quicker Access to Funding
Access to the cash freed up by the invoice finance company is relatively quick after finalisation of the contract. In many instances, businesses get access to the pre-agreed, discounted value of the outstanding invoices within 24 hours.
An Ongoing Source of Financial Support
Invoice financing offers companies unlimited access to funding, dependent only on the value of the outstanding invoices. Traditional bank loans have a set ceiling and strict repayment criteria, in terms of the interest rate paid on the capital and the monthly repayments expected.
Invoices Not Houses Are Put Forward as the Security
Another attractive benefit of invoice financing versus bank loans is that the asset backing the funding is the invoice. When applying for a bank loan, the bank requires the customer to secure the loan against either business or personal assets. It is commonplace for owners of small businesses to put up their homes as backing for a loan, which is not ideal because that puts their property at risk.
Service Payment Instead of Interest Charges
Invoice finance companies charge the company a service fee that falls due when the customer pays the invoice in full. A bank requires the company to pay interest at a rate that often depends on the risk profile of your business. That means the funding can be expensive for small companies that have not yet had time to build up a strong financial track record.
All-in-all invoice financing is a compelling alternative if you are seeking a flexible source of finance that will grow with you and tide you over the tough times.