Small businesses, particularly in the early stages of start-up, can struggle with their cash flow. ‘Cash is king‘, and it doesn’t matter how profitable or scalable your project or services are, to keep the business afloat it needs a healthy cash flow position at all times.
Business outgoings usually include wages, rent, inventory, data, voice, power services all of which are ongoing costs needing regular payments. With startups, cash movements need careful management, to flatten out the peaks and troughs in debtors payments.
In this article, we look at a couple of ways to keep the cash flow flowing.
There’s a ton of terminology in finance, so things often get confusing for the layperson, especially when not every provider uses the same terminology for their products. While some finance companies use an umbrella term ‘invoice financing‘, the same term is also used in much the same way as invoice discounting.
In your business you may also use the term invoice discounting when you offer your client a discount for quick payment of their invoice; however, it is better known as a short term loan product that uses the business’ accounts receivables as collateral. This type of financing is more flexible than another popular product – factoring. Both financing products are used to steady the cash flow challenges and they’re particularly popular with businesses that have higher margins and can, therefore, afford the services.
With invoice financing or discounting, it is a short term loan between the lender and the business with the clients usually unaware of the agreement. The business can choose the invoices it wants under the agreement and receives up to 95% of the invoice value, as a loan. When the customer pays the invoice the loan is repaid.
As with all loans, there is a rate of interest to pay and sometimes also a service fee. There is more flexibility with this loan, with a pay-as-you-go option as opposed to a locked-in contract. Plus the business is holding onto its accounts payable ledger and it’s responsible for chasing payments.
When using invoice factoring, your business has essentially sold the invoices (accounts receivables) to a third party and for a discount. The business hands over its credit control to the provider and with it the responsibility for chasing up payments. Your clients are fully informed of the arrangement insofar as they will be paying the factoring company not your business. Clients can also usually to pay in instalments, incurring a service fee and interest rate.
As we’re all aware, cash flow is the single biggest threat to companies. Being able to liquidate your accounts receivables into instant cash can be profoundly effective in overcoming cash flow issues. This is why invoice financing is very popular with businesses that have high cost of sales.
Typically, invoice financing is faster and more accessible than acquiring a bank loan. Bank loans are of course going to be more cost-effective with their low rates, but they take a long time to process (over a month) and have very high credit rating standards.
In contrast, invoice factoring can happen with mediocre credit ratings and can be acquired extremely quickly (which is important when cash flow is the issue).
Avoid Diluting Equity
One way many startups attain a cash injection is to dilute equity. Invoice discounting and factoring helps raise funds whilst retaining equity.
Believe it or not, invoice factoring may actually be more effective for your business than the short term loan solution that requires you to chase up invoices. Experienced debt collectors may find themselves retrieving funds faster than you otherwise would have so that time your business has saved.
The fees can be high so carefully consider the options before signing an agreement. A business loan will incur fewer fees and interest rate.
Manage Customers Expectations
Your business will need to manage customer expectations with invoices and payments when you use a factoring company. Your approach to debt collection is likely to be less assertive and you will need to seek to understand how it’s working out for them so your business gets their repeat business.
Banks and investors may be deterred by your use of invoice financing and factoring, as it can bee seen as a sign of a struggling business.
Your business may use factoring and discounting services to get gear up for further investment or to just through a period of trading woes. Whatever the reason, always seek expert advice before signing anything.