Invoice finance explained
Invoice finance allows businesses to leverage the value of their invoices (debtors) to have that money paid to them prior to the date the funds are actually due from their customers.
It can be considered an advance on the money owed to them, and can bolster cashflow and allow the business to trade freely by filling the gap in their cash flow cycle that may range from 30 to 180 days.
Invoice finance is useful as it doesn’t require a business to have property security, and repayment is generally based on invoice quality more than business performance, although business performance will be looked at for secondary exit.
Invoice finance is a catch all term for a number of variants of product, which we’ll discuss below under the headline terms of invoice discounting and invoice factoring. These products have important structural and legal differences.
Some additional considerations include that invoice finance can be against a group or ledger of invoices (most common), or against a single invoice.
Costs vary greatly between providers both in terms of how a business is charged and the expense itself. Generally a facility will have establishment fees, interest (charged in combinations down to daily), drawdown fees and a facility fee. Pricing can be very complex and you’re best to engage via your broker unless you’re particularly au fait with invoice finance.
What is invoice finance
Although there are variants to products depending on the lender, there are two main product groups;
Invoice discounting
Invoice discounting is most easily likened to a loan, in that the business maintains ownership of their invoices with the lender taking security over the invoices and lending against the value of those invoices, generally forwarding 60-80% of the invoice value.
The loan is then repaid by the business to the lender as customers pay their invoices. The business is liable should the invoices not be paid on time, although loans are generally established with a degree of breathing space for late payment.
A common structure is that a lender will forward say 80% of the invoice value, and when the invoice is paid by the customer the business repays the lender plus costs, which generally include an interest component and fees.
Discounting is generally ‘undisclosed’ in that the customer isn’t aware of the funding arrangement as they’re still making payment to the business.
Invoice factoring
Invoice factoring is when a funder (factor) buys outstanding invoices from the business, taking on legal ownership including obligation to collect funds from the debtor, and the non-payment risk associated with the invoice.
The funder will generally advance 60-80% of the invoice face value, with the remainder less finance costs (commonly structured as interest and/or fees) as paid to the business once the customer has paid the invoice to the factor.
Whilst the business frees itself of the obligation to chase payment, factoring is generally ‘disclosed’ in that the customer is aware of the funding arrangement given they now owe payment to then factor instead of the business they purchased from.
Why use invoice finance
Invoice finance is used as a cash flow tool. It allows a business to get advance payment of funds owed to them, so that they can operate freely without the disadvantages of a cash lag. For example a builder would use invoice finance so that they have the cash available to buy materials for a new job. It allows businesses to pay suppliers and invest in the growth of their business instead of waiting for their customers to pay them.
Who can use invoice finance
Theoretically invoice finance is available to anyone who uses trade terms, in that they deliver goods or services that are paid for on supply terms that may range from 30 - 180 days.
That said, most lenders do have restrictions in place relating primarily to invoice quality and minimum facility limits due to traditionally high operational costs of the product. The big banks tend to have facility limits from around $500,000 which is very restrictive to SME’s. Many of the fintech lenders who are invoice finance specialists have starting limits around the $10,000 - $15,000 mark.
The type of invoice and potentially the credit worthiness of the debtor may also be taken into consideration and prevent some invoices from being funded.
Who offers invoice finance
In Australia, there are many invoice finance providers, however it is a complex space and each lender does things slightly differently. As mentioned above, most big banks play in the higher end of the market with large minimum facility limits, whilst there are 15-20 players in the SME space.
Some of the key variants between providers are things such as LVR (percentage of face value they’ll advance), how costs are charged, product types offered (discounting, factoring), and importantly how the process works and the impost that has on the business.
Invoice finance is a very useful finance product though does come with some complexity, please reach out to us to guide you through the process and ensure you land with the right funding partner.
