Last updated on 26th November 2024.
Business lending, including funding solutions like Invoice Finance, has increased by almost 9% in Australia in 2024. For small and medium sized enterprises, this growth has surged by over 15.4% compared to the previous year!
With cash flow management and access to necessary working capital one of the most challenging obstacles preventing businesses from growing, Invoice Finance can be a uniquely suitable solution.
But what is Invoice Finance?
Invoice Finance is an increasingly common finance solution for SMEs looking to enhance their cash flow and increase access to working capital.
In short, this financial tool allows businesses to access funds tied up in outstanding invoices, offering a lifeline during times of cash flow constraints especially when it comes to meeting short term liquidity needs.
Understanding Invoice Finance
Invoice Finance is sometimes referred to as debtor finance or accounts receivable financing.
This category of business funding solutions allows businesses to access credit upfront by using outstanding customer invoices as collateral, rather than traditional assets like property.
Notably, Australian companies are paid 26.4 days late on average. This figure demonstrates the significant challenge faced by businesses, particularly SMEs, in managing cash flow and maintaining operational stability when faced with such long payment terms, plus less-than punctual customers.
How Invoice Finance Works
1. Application
To arrange Invoice Finance, a business must apply by submitting relevant financial information and details of outstanding invoices.
2. Approval
The application is then assessed by the lender and once approved, the finance provider will advance a percentage of the invoice value – most often somewhere between 80% and 95%.
3. Collection
The outstanding invoices then need to be paid. So either the finance provider or the business (see the types of Invoice Finance below) will ensure the debt is collected.
4. Final Payment
Once the customer pays the invoice, the remaining balance of its value is released to the business, minus any fees.
Why should you consider Invoice Finance?
Invoice Finance allows small and medium sized businesses to access future cash flow today. This access to working capital can help better manage cash flow, fund expansion or contracts, pay overhead and other expenditure costs, or consolidate other debt.
But Invoice Finance also offers some unique benefits.
Improved Cash Flow
Invoice Finance enables businesses to utilise its unpaid invoices and leverage them for immediate working capital. By improving cash flow and ensuring reliability in incoming cash businesses can better meet short-term obligations such as payroll, supplier payments, and operational costs.
Flexibility
Unlike traditional bank loans, Invoice Finance does not require fixed repayment schedules. The ‘repayments’ come in the form of the business’s customers settling their invoices. Plus, at ScotPac, we offer $10,000 – $150 million facility options so you can find a solution that will grow and scale with your business.
No Collateral
With Invoice Finance, the outstanding invoices serve as the security for the finance provider so you, as a business owner, do not need to put up any personal property or asset as collateral.
Understanding the Cost of Invoice Finance
The main cost of Invoice Finance comes in the form of fees. These fees vary by provider but typically include discount fees and interest charges based on the financed amount.
Additional fees, such as administrative or credit check fees can also apply. So it is important that you understand all associated costs with your finance provider when assessing whether Invoice Finance is right for you.
Types of Invoice Finance
Invoice financing generally falls into three categories:
- Invoice Factoring
- Invoice Discounting
- Selective Invoice Finance
What is Invoice Factoring?
With Invoice Factoring, a business basically sells its outstanding invoices to the finance provider who is then responsible for managing the collections and settling the accounts.
For this reason, Invoice Factoring is best for SMEs without an independent collections team or wanting to outsource accounts receivable services.
What is Invoice Discounting?
With Invoice Discounting, your business can access the line of credit but still retains control over collections. Larger businesses with more established and capable collections department may favour this type of Invoice Finance as it comes with more favourable terms and allows for more confidentiality with customers.
What is Selective Invoice Finance?
This flexible form of Invoice Finance allows for only specific invoices being used as collateral and thus being financed rather than all outstanding ones. Another term for Selective Invoice Finance is spot factoring. SMEs with a small number of customers but with high value invoices generally favour Selective Invoice Finance.
Is Invoice Finance Right for Your Business?
Determining whether invoice finance is suitable for your business will depend on certain factors, your business objectives and general needs. Here are some factors to consider:
1. Cash Flow Needs
If your business frequently faces cash flow gaps due to delayed payments, Invoice Finance can provide immediate and reliable financial relief.
2. Customer Base
Companies with reliable and long-term customers who pay on time (meaning by the end of the favourable payment terms) are ideal potential beneficiaries for this type of financing.
3. Business Growth Goals
If you plan to reinvest your profit into further business growth opportunities but lack immediate capital, invoice financing can serve as an advantageous and strategic funding source.
Maintaining Customer Relationships
Different types of Invoice Finance offer different levels of customer confidentiality. If maintaining confidentiality is critical for your business and you have the debt collection capacity to ensure payment on the outstanding invoices, there is the option to do so.
However, even when the funding arrangement is known, it can actually enhance customer relationships by ensuring timely payments and enabling businesses to offer more favourable payment terms. To ensure ongoing positive relationships, maintain open lines of communication and deliver high-quality goods/services to preserve customer satisfaction and secure future business opportunities.
What Happens if My Customer Doesn’t Pay the Invoice?
The responsibility for bad debt will mostly depend on the terms of your financing arrangement.
In most cases, your business will be responsible for any costs associated with any unpaid invoices. However, there are ways to mitigate this risk. Your finance provider will conduct due diligence before approving invoices for funding and Bad Debt Protection can safeguard your business against the risks associated with customer non-payment.
Invoice Finance vs Unsecured Business Loans
Like Invoice Finance, an unsecured Business Loan doesn’t require collateral. However, unsecured loans differ in that they provide a business with a one-off lump sum of working capital which is then repaid over a specified term in the form of regular repayments plus interest.
There are some key differences between Invoice Finance and unsecured Business Loans. For one, loans tend to require stricter eligibility criteria to be met. It is not uncommon, in the absence of security in the form of assets, for unsecured loans to require a personal guarantee.
Invoice Finance is far more flexible and does not have fixed repayment. In general, it is a more accessible form of funding for start-ups and SMEs who may not be able to qualify for a loan.
Find out more about Invoice Finance with ScotPac today
Invoice Finance can help you transform your outstanding invoices into instant funding with a range of flexible options. Our dedicated team of lending specialists will work with you to set up a tailored financial facility.
At ScotPac, we prioritise the growth of our clients and ensure their success remains at the heart of everything we do. That’s why we’re proud to say our clients grow at a rate three times faster than the average Australian business.
To discuss how Invoice Finance could benefit your business, get in touch with our team today.