COVID-19 has dramatically changed the business landscape, putting significant pressure on cash flow for many. While traditional responses to cash flow pressures abound, it may also be worth considering niche lending facilities, such as invoice financing. Here’s what you need to know.
Faced with hamstrung revenue streams and ongoing market uncertainty due to the impact of COVID-19, businesses around the country are considering what stimulus, rent relief and lending facilities they might access in order to reduce the burden.
For some business owners, the main options aren’t on the table. It may be that they’ve not faced enough of a drop in revenue (yet), or perhaps their existing debt levels prevent them from considering an emergency loan.
Whatever the case, if you’re struggling to work out how you can prop up your cash flow at a time like this, it may be time to consider things like invoice financing or factoring as niche lending facilities that could help you out in a pinch.
But what’s the difference between invoice financing and factoring, and which could suit your business best?
This article takes you through the basics of this types of niche lending and answers some common questions.
There are many different financing options out there that can be used to manage cash flow, whether to navigate tricky times or seize opportunities.
One option, which is often overlooked, is invoice financing. Invoice financing (also known as invoice discounting or receivables financing) usually invokes thoughts of factoring in the minds of both business owners and finance directors. But they’re vastly different in the way they operate.
Factoring is a process where businesses sell their outstanding invoices to a specialised financier at a discount. This discount is generally a percentage of the invoice and is charged to help cover the risk of the invoice collection from the financier’s perspective as well as the advancement of funds.
Discounts can typically be anywhere between one and four percent and there can also be fees associated with the facility overall, as well as for each transaction.
During the factoring process the invoice is assigned by the business to the financier, which means the debtor is made aware there’s a third party involved in the transaction. When the debtor pays the invoice, it gets paid directly to the financier. If an invoice is not paid on time, the financier completes collection activities.
As an example, if you were to sell an invoice of $100,000 at a four percent discount to a financier, you would most likely receive around $80,000 upfront and then the remaining $20,000 when the invoice is paid minus the four percent discount. The debtor would be notified to now pay the financier instead and the net amount received would be around $96,000. This can be an uncomfortable thing for most business owners as it takes the relationship with their debtor out of their hands, however it can also be an option that unlocks liquidity when it’s needed most.
Invoice finance uses some of the same concepts as factoring, but gives the business owner more control over the debtor relationship. Invoice Finance facilities generally operate as a line of credit for the business that is secured by the collective total of the invoices owed. This is generally a percentage of the total amount outstanding – typically around 70-80 percent.
Lenders have different cost structures and methods of accessing the line of credit, but in general the structure is closer to a regular business loan or overdraft. Generally, these facilities are completely invisible to the debtor, which allows a business to keep control of its invoicing and collection activities.
An example of this might be where you have the total amount of your outstanding invoices as $100,000. Your invoice finance facility limit could potentially be 70 percent of that total, which would give you access to $70,000. When accessing this money, it’s charged closer to how a bank overdraft works where you pay a service fee of as a percentage of your limit, usually somewhere around two percent and then perhaps 9-10 percent a year on the funds that you draw down from your approved limit.
This also allows you to access funding based on your cash flow needs – as you issue more invoices, your access to credit also increases. When invoices are paid by debtors, the funds are deposited to repay the amount outstanding.
Both factoring and invoice finance can be useful tools to help manage your cash flow, as they both help you get paid sooner, but with all of these things you should engage professional advice to see whether they are right for your specific situation.
This article does not constitute financial advice. All information provided here is general information and does not take into account your objectives, financial situation or needs.
For advice on your specific situation, MYOB recommends engaging a qualified professional directly.
MYOB is looking to speak to customers who may be interested in invoice financing as a product. Register your interest today.