More Routes to Financing for SMEson 31 January 2017
SMEs need to be adept at finding ways to save on expenses, but we can all agree that regular and healthy revenue is more important and that SMEs are particularly vulnerable when invoices don’t get paid on time. In addition to peer-to-peer funding and other types of alternative finance platforms, there exist invoice discounting and invoice factoring. In both, you’re seeking financing against the value of unpaid invoices.
Let’s look at the advantages and disadvantages of both.
This gets you an almost immediate cash infusion. You offer unpaid invoices to a financier against a percentage of the invoices’ total value, generally about 85 percent. You’ll then have a debt to the lender, which is paid down as the payments from your customers come in and go back to the lender. This system can work well for companies that find themselves in difficult situations – a sudden drop in business due to circumstances beyond control, a seasonal downturn, a late payment pileup that squeezes payroll – but if you’re willing to take the hit, you can also use this type of financing to get the necessary cash to grow or purchase equipment.
Pros and Cons
It’s definitely fast money. Lenders will examine both your business and those of the customers or clients who owe you money to calculate whether your invoices are worth the risk, but if you pass muster you’ll receive funds within days or even hours.
There are a few drawbacks to consider. First, you will still be responsible for obtaining the payments you’re owed, though of course you’ll have the added motivation of the new debt to put a little shoulder into that task. Second, don’t forget that ‘discounting’ part of the equation – you won’t be getting the full amount you were originally owed.
As mentioned above, potential lenders will be looking at both your company and those that owe you money to evaluate whether you are a good risk. Do you have a lot of invoices outstanding or just a few big ones? Is your own solvency dependent on customers in questionable circumstances themselves?
If your long-term prospects look good but you just find yourself in temporary straits, invoice discounting is a reasonable pursuit and it is available to companies of all sizes.
In a factoring process, you present all unpaid invoices to a lender (called the ‘factor); you don’t pick and choose. Again, the potential financier will look at your whole picture – what you’re owed and by whom, your overall financial health, and so on. If you’re deemed a good risk, the lender will quickly pay you usually a percentage of the total outstanding debt and then pursue the payment on your behalf, remitting the remaining monies to you as they get paid. These deals can vary in how they’re structured.
Pros and Cons
First, you pay interest and fees, but you will get all of the money you’re owed from your customers after the payments have been obtained by the lender. Looks good on the surface, but those fees and interest can end up being expensive, so you want to shop carefully and read all the fine print on what you’ll owe.
The next item in the pro column – and the reason that this can be the start of a beautiful relationship – is that some factoring companies will protect you against bad debts and check the credit of prospective customers, so you may be less likely to get stuck with unpaid invoices in the future.
Another benefit of factoring is that your time and energy will be liberated from chasing payments, allowing you to actually get back to running your business. The con here is that by turning over everything to another company, you also aren’t managing at least the payment side of your customer relationships. Maybe some of them haven’t been worth the hassle they’ve caused you with their non-payment, but maybe you’d be willing to continue to work with others – with factoring, you don’t have a choice in which invoices you pursue.
The final and perhaps biggest reason that factoring should not be your first resort is that it will damage your own credit-worthiness. If you think that later on you might need a loan – whether through a traditional bank or an alternative source – the invoice factoring will need to be explained.
Although the HMRC has inadequately guarded businesses from late payments, it does offer some help and information for businesses seeking finance.
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