03 Dec Pros and Cons of Invoice Financing
Invoice financing has long been a method for small and medium businesses to improve their cash flow when there are invoices that are outstanding with long payment terms. Small businesses often struggle with their cash flow. Although they have made sales, payment may elude them for some time based on the payment terms they have been forced to agree to in sales negotiations. Thirty days, and up to 120 days is not uncommon for payment terms, which means there is no cash available to pay day to day expenses until the invoice is paid.
This is the big advantage of invoice financing. A 3rd party lender will advance up to 85% of the invoice as a loan to the small business in advance of the invoice actual payment date.
Pros and Cons of Invoice Financing
Invoice financing comes in several forms. First there is invoice discounting which provides the small business with a percentage of the invoice as previously mentioned. The small business remains in control of accounts receivables and collection of the outstanding invoices. Invoice factoring involves selling the invoices to a 3rd party who collects the invoice amounts from the customer. There are advantages and disadvantages associated with each of these scenarios.
Cash flow is improved for the business since they will receive a percentage of the invoice well in advance of when they would normally be paid.
Invoice discounting can be kept private between the customer and the small business. As far as both customers and suppliers are concerned it is business as usual.
Interest terms can be more attractive in these situations since the outstanding invoices are being used as collateral for the loan associated with invoice discounting
Invoice factoring turns over responsibility for collections to a 3rd party, reducing your sales cost, however this could have a negative impact on your customer relationships.
Some customers may pay more promptly to a 3rd party when using invoice factoring.
Non payment by customers can be factored into invoice factoring arrangements.
Depending on the terms of the arrangement, there will be increased costs associated with invoice financing which will impact profitability of the company.
Invoice factoring turns collection of the invoices over to a 3rd party which could have an impact on the customer relationship and future sales.
Suppliers who become aware that invoice financing is being utilized may not want to extend long payment terms for raw materials.
Your company may find it more difficult to obtain other types of loans when using invoice financing since accounts receivables will be lower.
Once a small business becomes dependent on invoice financing, it may be difficult to exit from this strategy. Notice will be required and all monies repaid before agreements can be terminated. This can have an impact on cash flow and company operations.
Invoice financing can provide much needed cash flow solutions to business enterprises. Cash can be used to meet operations requirements, supplier invoices and capital acquisitions. There is a cost to utilizing invoice financing solutions which will impact corporate profitability to some degree. Invoice discounting and invoice factoring both have their advantages and disadvantages. Depending on the situation they may make sense for small and medium business. Call today to obtain more information about this potential cash flow solution for your company.