post by:
Michael Goldstein
There is no substitute for a good financing option. When considering interest rates, factoring options, and loans it seems like all the options blur together. The fact is, you want to raise capital with as little hassle as possible.
While you are researching your options, you may have come across invoice financing (hence, how you ended up here). Invoice financing is a great way to increase your immediate cash flow. Let’s take a look at what is involved with invoice financing.
What is Invoice Financing?
Invoice financing is simply selling your unpaid invoices in exchange for capital. Your invoices are promised payments from your customer that you have yet to collect on. Essentially, those unpaid invoices are promised payments but until they are collected, they are not making you any money.
Unpaid invoices are not able to generate passive income – you can’t invest it and you can’t put it back into your business (yet). So for up to thirty days (or whenever your payment due date is), those invoices are just sitting in your filing cabinet. When you need cash flow now, you have something of value to exchange for capital now.
How Does Invoice Financing Work?
Rather than dealing with interest, invoice financing is a simple exchange of unpaid invoices for funding. The invoice purchaser buys the invoices at a discount rate – this is how you avoid paying interest. You turn over the invoices and the buyer collects the payment directly from your customers.
In order for invoice financing to work, you must have collectable, unpaid invoices from credible customers. The financing company is not interested in tracking down customers who make late payments.
Pros and Cons of Invoice Financing
Invoice financing can benefit your business by providing fast capital. However, invoice financing is not for everyone. It is important that you review the pros and cons of all financial options to find what works best for you.
Pros of Invoice Financing
Access to fast funding – After approval, you can usually receive your money within a day. You can unlock up to 100% of the value of the invoices (most financiers will give you 50-80% of the value of the invoices) almost immediately instead of waiting for the customer to settle their bill.
High approval rate – Traditional business bank loans are approved for less than 14% of businesses. Invoice financing is available to any business that uses invoices to receive payment from their customers.
Minimized risk – Your invoices are your collateral which reduces your personal and business risk. Your personal and business assets remain untouched.
Use the money how you see fit – There are no restrictions on how you spend the money. While some financing options limit you to inventory or debt repayment, you can use invoice factoring to finance any part of your business.
Pros of Invoice Financing
Less profit for you – Naturally, selling your invoices at a rate lower than their value will cut into your profits. You are taking a temporary hit on your bottom line each time you sell a batch of receivables.
Customers may not pay on time – For every invoice that is left unpaid, you could incur penalties. Ultimately you are still responsible for the totality of the loan, so if your customers do not pay, you will.
Additional fees – One of the fees you could encounter is late repayment fees. If your customers do not pay, the financier may charge you 2-5% of the total loan amount every week until the balance is paid. Additionally, invoice financing has a bit of a shady past – including dishonest lenders. While most of that is in the past, it is important to keep an eye out for hidden costs/fees so you don’t find yourself in an impossible situation.
Temporary fix – You have to remember, this is only a bandaid on a larger cash flow problem. If you continue to rely on invoice financing without growing and scaling your business, you may lose the ability to do so in the long run.
Alternatives to Invoice Financing
So maybe you are thinking that invoice factoring is not for you. Perhaps you don’t deal in invoices and prefer immediate payment from your customers. We have a few alternatives to investigate.
Revenue Share Agreements
Revenue share agreements allow you to acquire capital without complicated repayment. Once you receive your capital, you can usually spend it in any way that benefits your company and your goals. You then begin to make repayments based on your monthly revenue. The lender will take a percentage of your revenue, allowing for flexible repayment.
The idea is that revenue share agreements take the pressure off the borrower by only requiring a percentage of what is coming in. Traditional bank loans require you to pay a fixed monthly payment, including interest, regardless of the revenue you bring in. On low revenue months you will pay less, and on higher revenue months you will pay more, but it will be the same percentage.
Business Line of Credit
Business lines of credit function like a business credit card without the physical card. This line of funding allows you to draw from the loan, transfer it to your bank account of your choice and make repayments to the loan just as you would with a traditional loan or credit card.
Many business lines of credit allow you to draw and repay several times without applying for new financing. This is a revolving line of credit. As you make payments, the principal amount becomes available to draw from again.
Merchant Cash Advance (MCA)
Merchant Cash Advances, or merchant capital advances, are a mix of revenue share agreements and traditional loans. MCAs are not considered a “loan” and are not regulated by the federal government, giving lenders and borrowers more freedom to conduct business.
When capital is lended through an MCA, the borrower begins to make repayments through a daily percentage of sales made with credit and debit cards. You can receive an advance up to 95% of your revenue received through credit and online transactions. Then you begin to make repayments on a daily basis.