Invoice Financing Versus Bank Loans

Both bank loans and invoice financing are favourable sources of finance for businesses but what is invoice financing and how does it differ from a bank loan?

Bank loans are credit facilities offered by banks, with a fixed amount, usually a fixed term and repayments required on a regular basis.

Factoring and invoice discounting have become a major source of working capital finance resulting from the credit crunch and the difficulties facing a lot of business in securing a bank loan. Capital is created out of a business’ outstanding invoices. The invoice financier essentially lends the business money against its unpaid invoices, usually an agreed percentage of the total value of the invoices. As the customers pay their invoices, the money goes to the invoice financier, reducing the amount owed and allowing more borrowing on the invoices from new sales, again up to the percentage previously agreed.

So what are the advantages to invoice financing?

  • The various forms of invoice financing allow businesses to free up capital tied up in invoices with long remittance terms.
  • It can be arranged confidentially so customers won’t know what the business is borrowing against their invoices.
  • Once an invoice is raised up to 90% of the invoice value could be available with 24-48 hours, funds are made available quicker when compared with bank loans.
  • Better cash flow gives increased bargaining power with suppliers and less need to concede discounts to customers.
  • Removal of cash flow worries allows more time to be spent developing and improving the business.
  • Fewer conditional requirements.
  • Comparatively, it offers a more cost-effective facility.

Are there disadvantages to invoice financing?

  • Businesses lose profit from orders or services that they provide.
  • Invoice financiers will usually only buy commercial invoices.
  • It may affect the ability of a business to obtain other funding due to the lack of ‘book debts’ that can be offered as security for other loans.
  • Once a business enters into an invoice discounting arrangement it can be difficult to leave as the business becomes reliant on the improved cash flow.

What type of businesses are best suited to invoice financing?

  • Invoice financing is suitable for most business in the manufacturing, business services and distributive trade sectors in the UK selling goods and services to other businesses on normal credit terms and who are seeking short term borrowing aimed at specifically improving its working capital and cash flow position.
  • The key point is that no business is excluded, even those making trade losses since the invoice financing company’s security is primarily its customers (through the invoices). Invoice financing facilities are therefore available to sole traders, partnerships, limited companies, plc’s and new start–ups.

Are there particular types of businesses which are not suitable for invoice financing?

Potential problematic areas for invoice financing are:

  • Maintenance contracts.
  • Stage payments.
  • Long term contracts and retentions.

However, even if your business does contain any of the above elements, there are specialist trade financiers who may be able to assist. It should also be borne in mind that various banks, financial institutions and invoice financiers offer a range of invoice financing products making invoice financing potentially an attractive alternative form of funding for businesses.

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While great care has been taken in the preparation of the content of this article, it does not purport to be a comprehensive statement of the relevant law and full professional advice should be taken before any action is taken in reliance on any item covered.