How does invoice finance work?

What is invoice finance?

Invoice finance is a solution to late payment of invoices  – a major problem for Australian SMEs, which can lead to the closure of businesses in extreme cases. At the very least, late payments create problems such as:

  • Uneven cash flow, potentially leading to problems paying suppliers and staff.
  • Missed opportunities such as early payment discounts from suppliers.
  • Falling behind in tax payments.

The latest research from Dun and Bradstreet revealed that one third of Australian SMEs (which it defines as businesses with less than 500 employees) experience problems with late payment of invoices. Clients and customers often shut down for an extended period over Christmas and New Year, which exacerbates the problem. That’s a significant number of businesses when you consider that the latest ABS count of Australian businesses revealed that 99.5% have less than 200 employees.

Invoice finance (also known as factoring, debtor financing, cash-flow finance and invoice discounting) is simply a line of credit against the receivables of a business. It enables SMEs to convert unpaid invoices to cash by leveraging their accounts receivable, typically one of the largest assets on the balance sheet.

The invoice finance process involves payment of up to 85% of the value of an outstanding invoice up front. AIF, for example, provides same-day approval. We pay the remaining 15% of the invoice value to the company, less around 2% service fee, once the outstanding invoice is paid.

The invoice finance process

A diagram showing the Austif invoice finance process in 5 steps.

 

Why small businesses should consider invoice finance

There are three main reasons why businesses should consider debtor finance for cash flow management. Firstly, the finance landscape has changed: there is a lack of competition among Australian SME lenders. This has made it increasingly difficult for SMEs to rely on banks for financing.

Secondly, as a result of subdued economic conditions, many businesses have encountered cash-flow shortages. This has significantly impacted their operations and growth opportunities. And finally, SMEs don’t want to risk personal property to secure finance.

Invoice finance is based on invoices and does not require property as security, unlike other forms of small business finance.

An invoice financing facility may also include:

  • A sales ledger management service that can issue statements on a regular basis.
  • Handling of cash allocations.
  • Collection of outstanding payments.
  • Maintaining detailed accounts of a business’ transactions.

These factors can help SMEs reduce costs and free up management time to focus on strategic issues and business development.

Invoice finance facilities are structured in two main ways: Invoice factoring and invoice discounting. Under invoice factoring, the finance provider assumes control of the client’s sales ledger and liaises with debtors for payment of outstanding invoices.

To ensure they find a partnership that is a good, business owners should speak to at least a couple of invoice finance providers prior to signing a contract.

Questions you maybe asked:

Invoice finance providers may ask questions of clients such as:

  • What type of business are you in? – Invoice finance providers prefer to deal with businesses selling a product or service which has clear evidence of having been provided e.g. by a signed delivery note or timesheet.
  • What debtors do you have? – Invoice finance providers will want to understand the quality and spread of a client’s debtors before entering into an arrangement. They will also typically enquire about a business’ bad-debt record, the age of the sales ledger and overall collection performance.
  • How good is your record keeping? – Invoice finance providers must be sure that invoices can be easily followed through the collection process.

Find out more about how invoice finance can help your business:

Click here to contact an AIF invoice finance expert who can help your business with turnaround finance.

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