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Companies that need additional finance have more than one source of funding available. Business loans are available through banks, but there are other resources as well. Finding the right solution involves careful research and time spent analysing the company’s specific requirements.

Government Loans

Companies looking for business loans often check out their bank first, but this is not always the best solution for business financing. In addition to the banks, the government offers some financing in the way of grants and loans. These can be difficult to obtain, but are available to qualifying businesses.

Private Grants

Some private organisations also offer grants to businesses. These investors obviously expect to see something in return for their money, such as a financial interest in the company. Private investors benefit businesses in that they often do not require a payment in cash, but rather through a stake in the company’s assets.

Invoice Factoring

Invoice financial factoring through a factoring broker is another option. This uses future invoices as a funding source to provide immediate cash for the business. This is an affordable solution for companies that have future invoices to draw from.

One of the problems facing a newly formed company is that lending institutions are particularly hesitant to make new business loans. New businesses are notorious for closing at almost the same rate as they begin trading; they often lose money in the first few years. Once a business is established, obtaining loans is less of a problem, but until then new start-ups generally have to rely exclusively on internal funding. However, an alternative to business loans, known as invoice factoring, makes obtaining new business loans unnecessary.

Invoice factoring, also referred to as invoice or debtor finance, involves a lender, the factor, paying a percentage of the value of a company’s sales invoices upfront and collecting the debt from the company’s clients. After receiving payment, the factor then reimburses the company with whatever monies are left after deducting the upfront payment and any interest and charges.

In this way, rather than repeatedly having to apply for new loans, the company receives monies to cover its operating costs in a predictable and continuous manner, with the lender using the invoices as a form of collateral. The company has a regular cashflow and saves money on the billing and collecting of accounts receivable, because the job is taken over by the factoring company. Friction between slow-paying clients is eliminated by allowing a third party to handle collections and the company is able to concentrate its efforts on building a strong customer base, rather than spending time on credit control.

Invoice factoring is used by businesses for a variety of reasons, but most commonly to increase working capital and improve cash flow.  It can be a useful source of funding for start-up businesses that have plenty of orders but find difficulty obtaining new business loans to fund them.  Similarly, any business with an immediate problem obtaining cash to meet its obligations might find a factoring service helpful.

Invoice factoring can also be a way of reducing administrative overheads, as the factoring company will take on responsibility for collecting payments due on the outstanding invoices.  Furthermore, the factoring company can help with credit management and, depending on the type of agreement, take on the liability for bad debts.

New business loans or other types of business loan can potentially be used instead to provide funds to support a business.  However, the business will need to be able to show that it is able to repay the loan.  Invoice factoring advances money against invoices raised for work that has already been completed and so there is less risk that the money will not be available to repay the loan.  It is therefore often easier to obtain than some other sources of finance.

Business finance is probably as old as trading itself. Even a thriving company sometimes runs into cash flow problems or needs funds urgently to purchase additional machinery or tools. Any business that receives an unusually large order might find it difficult to fulfil such an order without having access to cash reserves.

Traditionally, banks were the main way of getting business finance. The fact that they have rather stringent credit requirements and take a long time to make a decision has resulted in more and more businesses looking for an alternative, which they frequently find in the form of invoice financing.

Gone are the days of having to submit stacks of financial statements and your business’s credit record being scrutinised under a magnifying glass before your application could be approved. Gone also are weeks of waiting anxiously for the bank’s decision and once more waiting for them to pay the money into your bank account.

With invoice financing all you have to prove is a good quality debtors book. Your business also needs to have a certain minimum yearly turnover, usually around £50 000; in addition your customers need to be other companies rather than private individuals.

Once your application has been processed the money can be in your bank account, often within 24 hours. This is of course good news for a business that needs cash urgently.

Usually, the invoice factoring company will take over your debt collection. If you do not warm to the idea of someone else chasing your debtors for money, you can opt for invoice discounting, which means you still have to collect the money and then pay it over to the factor.

There are, of course, costs involved, usually between 1.5% and 3.5% of the amount of the cash advance. Unless you have opted for non-recourse financing, you will also be liable for money that cannot be collected from your debtors.

It can be confusing choosing a factoring company when there are so many different alternatives on the market, often with subtle differences between the services they offer.  One solution is to use a broker such as Touch Financial.  Touch Financial is partnered with a wide range of factors and can supply quotes for various invoice financing services.

It is worth contacting more than one factor before making a decision, so that an informed choice can be made.  A list of factors can be obtained from the Asset Based Finance Association.

One way to find out more information about a factoring company is to talk to some of its customers.  If a company is not willing to let a potential client talk to existing customers, there could be some cause for concern.  Even better is to obtain a personal recommendation if this option is available.  The general reputation of a company is also important to bear in mind.

Questions to consider when weighing up options are: the factor’s previous record in collecting debts; the way the factor operates; how disputes and queries are dealt with; what the factor’s general outlook is on business; does the factor have knowledge of the business’s particular industry; how does the company communicate with a business’s customers; what happens if the credit limit is exceeded; what is the notice period that must be given to finish the agreement and what is the procedure for doing so?

The answers to these points should go a long way in determining the suitability of an individual factoring company for a business’s needs.

‘Small Business Finance for Dummies’ is a book by Faith Glasgow, part of the Dummies series from John Wiley and Sons. The book deals with all aspects of business finance for small companies, from bookkeeping to payroll.

The ‘For Dummies’ Series

The ‘For Dummies’ series of books was started in 1991, with a guide to the DOS computer operating system. Since then, it has expanded to over 16,000 titles on subjects as diverse as musical instruments and parenting. The subtitle for all the books is ‘A reference for the rest of us’, indicating its philosophy of user friendliness and some humour.

The Book

The book is divided into six sections. The first is an introduction to the subject, the second covers basic accounting, the third financial reporting, the fourth financial management, the fifth payroll and the sixth tax. It is designed to be dipped into, rather than being read from cover to cover and the sections can be read in any order. It is ideal for anyone who is just starting out in business, as it walks the reader through all aspects of business finance in simple, jargon-free language.

One advantage of applying for secured business loans is that it is easier for a lender to say ‘yes’ if there is guaranteed collateral for the funds they lend. Another advantage is that it is possible to borrow larger sums of money than is generally the case with an unsecured loan. Touch Financial business loans are also more likely to be available over a longer time period.

Business loans requiring security include those that use invoice discounting services; those that use invoice finance – including factoring; funds provided that are backed by the value of assets, and commercial mortgages.

Invoice discounting normally requires businesses to have an annual turnover in excess of £500,000, so this option is generally not suitable for the smaller companies or micro-businesses. Loans secured using invoice finance are based on using the value of outstanding invoices due to a company, or its accounts receivable, as collateral. These are available to, and often suitable for, smaller companies, providing turnover is in the region of £50,000 per annum.

Commercial Mortgages

A commercial mortgage is another type of secured business loan and operates similar to mortgage on a home or other personal property. If a business plans to buy a new asset – for example land or property – the loan can be secured on what the business purchases. Just like buying a house, however, this is a long-term financial arrangement, so may not be flexible enough in every case to meet changing business needs.

Tips When Arranging Loans

Always read the small print in a mortgage agreement, to check if there are any penalties for early repayment or making changes to the terms and conditions. Besides reading the small print, always check that the quote is for the APR, which is the full annual cost of a loan after fees, and not just a flat or linear rate. Finally, consider whether the level of security is appropriate to the amount of a loan. Is it worth securing a loan for £3,000 on a property worth £150,000 for example? Would the property be lost if a repayment difficulty arose? Taking financial advice before proceeding with a business loan arrangement should assist with avoiding any pitfalls.

Invoice finance is a route to funding cash flow where the billing capacity of a business is the key to releasing funds. There are two main methods to choose from: invoice discounting and factoring.

Invoice Discounting

This type of invoice finance service balances the value of invoices against the cash needs of the business. Basically, a lender agrees to release funds to a business based on the value of outstanding invoices – usually on a percentage basis. The business retains full control of the sales ledger and may make arrangements for insurance or other protection against bad debts. The use of invoice discounting can be confidential, so that the customers of the business do not have to know such a system is in place. Some businesses fear such knowledge would signal financial difficulties and prefer the arrangement to remain private.

Factoring

Whilst a similar arrangement is put in place for factoring – again the lender agrees to release an agreed amount of the value of outstanding invoices to the business – the difference here is that the lender takes control of the sales ledger. Smaller companies find that this can be of benefit in the pursuit of outstanding debts, as these become the province of the lender, whose third-party status provides additional influence or gravitas.

Invoice financing is a method of increasing cashflow by ‘selling’ your outstanding invoices to a lender, who will then give you an injection of some 80-90% of the value of those invoices. There are two types of invoice finance, factoring and invoice discounting. The difference between the two is that with factoring, the lender collects the debts for you, whereas invoice discounting is anonymous, as you collect the debts yourself.

Which Invoice Finance Option Should I Choose?

Invoice discounting and factoring are designed for two different types of client. Invoice discounting is for larger companies that have their own financial departments and well-established credit control and sales ledger systems. Factoring is usually used by smaller businesses that wish to outsource their entire sales ledger functions; the lender effectively becomes your credit control department. 

Invoice Finance Versus Other Methods of Financing

Invoice financing is one of several options available to businesses; others include asset-based lending, loans and overdrafts. The Royal Bank of Scotland’s website offers a detailed comparison chart that shows the advantages and disadvantages of each method. In short, you should use invoice financing when your company provides goods and services to other businesses and is not paid in cash. In addition, the lender will usually require strong proof of debt in the form of delivery notes and/or timesheets. Asset based lending is for larger companies whose capital is tied up in tangible assets, such as plant, machinery or property. Loans and overdrafts are best for established companies with a good credit history, though invoice financing is beginning to eclipse these more traditional methods of financing in popularity.

Cash flow is the lifeblood of any business. It is the fuel and food enabling the business to persist and grow. But cash flow does not always run smoothly, invoice settlement is often subject to normal business terms, imposing delays of 30, 60, 90 or even 120 days. A business may have considerable development costs that eat cash ahead of consistent sales income. There are a number of good reasons cash flow can be a problem.

Invoice financing is the umbrella term for a range of solutions to business cash flow difficulties offered by banks and finance houses. In simple terms, business to business invoices can be turned into short term business loans worth up to 85-90% of the invoice total. 

There are three separate types of arrangement under the banner of invoice financing, invoice discounting, factoring, and asset based lending. These three options are tailored to meet different requirements of businesses looking to accelerate their cash flow, and incur some fees and interest on the monies advanced.

In simple terms, invoice discounting provides cash within 24 hours of submitting an invoice to the finance house. The borrowing business must have sound sales ledger and credit control mechanisms. 

Factoring is much the same except that it is aimed at smaller businesses, with the finance company taking over collection and debt recovery, freeing management time for other matters.

Asset based lending is aligned with the needs and potential of larger companies by taking physical assets into consideration, so releasing cash tied up in capital for immediate use.