“How does Invoice Finance work?” you might ask. Also known as Confidential Invoice Discounting, Invoice Finance is a not-so-secret weapon in the world of business growth.
This type of Working Capital Facility provided by banks and other financial institutions is an often misunderstood but powerful tool for boosting your cash flow.
So, how can it benefit your business? Let’s delve in.
First, What Is It And How Does Invoice Finance Work?
Invoice Finance is reasonably simple, although some like to complicate it. In a nutshell, you arrange a facility with a bank or a finance house, allowing you to raise finance (get cash in your bank account!) on your invoices as you issue them. They effectively purchase these invoices from you.
Let’s paint a picture. Suppose you raise an invoice for £10,000 today, and your agreed prepayment percentage is 80%. This means you can draw down £8,000 – which is 80% of £10,000 – immediately, or in some cases, the following day, depending on your finance company’s system.
Simple as that.
So, How Much Does Invoice Financing Cost?
In short, not as much as you think! Let’s break it down.
Invoice financing comes with two main cost elements. First, there’s a fee for providing the facility, typically ranging between 0.2% and 2% of the invoice value. This fee is the cost of using the service and is often dependent on the volume and value of your invoices.
Second, you’ll incur an interest rate on the outstanding ‘credit’ derived from your invoice. This interest is only applicable while the money is outstanding, similar to a conventional loan.
Therefore, the total cost of using Invoice Financing is a combination of these two elements. It’s essential to factor in both while considering Invoice Financing as a cash flow solution for your business.
A Worked Example…
Let’s imagine you have a £10,000 invoice, and your Invoice Finance provider offers you an 80% prepayment, meaning you can immediately access £8,000. The costs involved would be as follows:
- Fee for Providing the Facility: Suppose the fee is 1%. This percentage is applied to the full invoice value. So, 1% of £10,000 would amount to £100.
- Interest Rate: Now, let’s calculate the interest. For this example, we’ll assume the invoice is paid after 30 days (1 month). With an annual interest rate of 5%, the monthly rate would be approximately 0.42% (5% divided by 12 months). Applying this to the £8,000 advanced, the interest for 30 days would amount to approximately £33.33 (£8000 * 0.42%).
So, in this scenario, the total cost of the Invoice Finance service would be the fee (£100) plus the interest (£33.33), which equals £133.33. Yes, you read that right…only £133! You’d receive £8,000 upfront, and once the customer pays the invoice, you’d get the remaining 20% of the invoice (£2,000), minus the fee and interest, resulting in a final payment of £1,866.67 (£2,000 – £133.33).
The Benefits Of Invoice Finance
Many believe Invoice Finance is an expensive proposition, but I always ask: expensive compared to what? The days of generous overdraft facilities are long gone. The chances of securing a significant overdraft without substantial security or personal guarantees are slim. So, if you’re comparing apples to apples, Invoice Finance often comes out on top.
In a business where you’d struggle to secure a significant overdraft, Invoice Finance can fill the gap, without resorting to equity or investment, which would likely prove far more expensive.
Invoice Finance provides much needed (and relatively inexpensive) liquidity.
Should You Consider Invoice Finance?
Any business seeking a flexible and straightforward method to bolster their cash flow should consider Invoice Finance. It’s a fantastic way of enabling growth. However, businesses with highly seasonal fluctuations or certain sectors might find Invoice Finance less suitable as sharp drops in invoicing can limit available funds.
Any Downsides?
Despite the potential challenges for seasonal businesses or certain sectors, I believe there are few downsides to an Invoice Finance Facility. The flexibility and immediate cash injection it provides can be a game-changer for many businesses.
Why Invoice Finance?
Many of my clients use Invoice Finance, and they swear by it as a primary tool for funding profitable growth. While individual experiences may vary, the overwhelming majority find the benefits far outweigh any costs or challenges.
The Bottom Line…
Invoice Finance isn’t a one-size-fits-all solution, but for many businesses, it’s a potent tool in their financial arsenal. You must understand how it works, the costs involved, and how it compares to other financial options. As always, ensure you’re comparing like with like, and don’t let confusion muddy the waters.
If you’re looking to learn more about Invoice Finance, I highly recommend joining my Know Your Numbers Mastery Groups. There, Invoice Finance is frequently discussed, and you’ll become an expert in it very quickly… and help your business thrive in the process!
