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Why use Invoice Financing? It’s a good question. I have always been very wary; it seemed like an unnecessary service provided by banks to make even more money. This is no longer the case.
Business to Consumer (B2C) transactions are, by and large, instantaneous. The supplier charges customers immediately at the point a product or service is provided (like when you buy something in a shop, for example, you pay for it before you leave).
The world of business operates differently. Business to Business (B2B) transactions often take place on account, with the supplier extending credit to the customer. At the time goods or services are provided, the customer is given an invoice which must be paid, normally within 30 days or at the end of the following month, depending on the company.
This is a long time, especially for smaller companies. Imagine if a customer buys something from you on the 1st of the month – then you don’t get paid until the end of the following month – you still have to run your business the whole time, paying suppliers, wages and other overheads. This is why cash flow is so important. One of my favourite sayings in business is:
[Tweet “Turnover is vanity. Profit is sanity. Cash Flow is reality!”]
The truth is, it’s rarely possible to fund everything you do with your own cash. An example of when this might be the case is if a customer suddenly places an exceptionally large order with you.
The traditional solution to this was a service provided by banks called factoring. In simple terms, factoring is when a company ‘sells’ invoices to a bank at a discount. This allows companies to receive cash immediately, well before they would normally be paid.
This is all well and good but dealing with banks is often very laborious. Factoring takes a long time to set up and usually requires legal sign-off, which can be expensive. I have always shied away from factoring for this reason. An alternative to banks was securing finance from individual private investors – but again this can be laborious and expensive with lots of hoops to jump through.
In recent years there has been a (much needed!) shake-up in the financial industry, spearheaded by a model known as crowdfunding. Businesses are no longer restricted to banks when it comes to funding ventures; they can raise finance from a group of private investors, who opt to put in as much or as little as they like. Such a model is known as Peer to Peer lending and there are a lot of companies now offering this service.
Perhaps the most well-known Crowdfunding website in the UK is Funding Circle, who mainly offer commercial loans, plus other services like asset finance. They don’t do Invoice Financing. But other companies do, like Market Invoice.
Raising capital from Market Invoice is appealing for a number of reasons. It’s quick and easy to setup, it doesn’t require any tangible security, repayment terms are flexible and the exercise can be repeated as many times as necessary, with favourable rates for repeated use. Unlike companies such as Funding Circle, who offer a range of services, Marketing Invoice only provide Invoice Financing. It’s their niche. It is also massively streamlined over high street banks. And above all else… it’s cheaper.
For the investor: the returns are good, you can spread risk by funding a small amount into lots of ventures (rather than having all your eggs in one basket), you can put as much or as little as you choose into a a company and the returns are normally much better than putting money in building societies and savings accounts, not to mention more exciting.
It isn’t uncommon for high-growth companies to utilise third party financing – it acts as a catalyst to growth – but it’s not just high-growth companies who might use Invoice Financing.
Some sectors are more likely to be using the facility than others i.e. those with high upfront material costs or high running costs like fuel or staff. Manufacturing, Wholesale Logistics, Construction, Haulage, Agency Recruitment and Printing Companies are classic examples.
Some industries also have commonly accepted payment terms of 60, 90, even 120 days, such as government contracts. In the past, where these organisations may have used broader invoice financing (i.e. factoring) they are now attracted to invoice financing.
Invoice financing is also useful if you can’t get credit from suppliers but need products from them (it might be your supplier who is finding cashflow challenging).
I should add a quick sentence about the risks involved. It goes without saying that Invoice financing is not without some risk. There is always a risk that your customer may not pay you and there is also the risk that you may not get funding, although this is relatively rare. Worst-case scenario, if you fail to repay a loan you can end up in court. But this would likely be the same even if you were using a different source for your finance.
In my opinion, you have to speculate to accumulate. And with risk comes reward. It is things like Invoice Financing which helps companies grow quickly. It’s one of the tools of the modern business world which have been brought about by the Internet and if mastered correctly can be tremendously powerful.