The process of cash flow financing will probably be familiar to anyone who has ever run a small company or dealt with business accounting. Very simply, it is a means of raising additional funds to cover anticipated revenue shortfalls. This is usually done so businesses can meet all financial obligations (bills, staffing costs, etc.) that can’t be afforded due to cash flow problems.
Essentially cash flow financing solutions are short-term loans based on projected income and are particularly valuable for start-ups and businesses trying to initiate periods of growth. The most common form of invoice finance is factoring, but other methods include invoice discounting, block discounting and payroll finance. With so much choice on offer, there is bound to be one that perfectly suits the needs of your business.
With an invoice factoring agreement, a factor (either a bank or invoice factoring company) will buy your invoices owed, releasing around 90% of their value to you straightaway. It is particularly suitable for businesses that find themselves cash poor because commercial customers aren’t paying invoices on time.
You will need to decide between 2 cash flow solutions: recourse factoring and non-recourse factoring, which relate to the main risk: if the debtor cannot or will not pay.
The liability for unpaid invoices eventually falls back to the company that issued the invoice. Because the factor takes no risks in this process, the rates offered are usually far more attractive.
The exact opposite. If an invoice remains unpaid (if the debtor has ceased to trade for example) then the factoring company swallows this debt on your behalf. This gives your business a much higher level of security, although the percentage of the invoice paid by the factor is usually much lower.
These contracts apply to domestic businesses that trade within the UK. However, for companies that issue a large number of foreign invoices, an international factoring solution will be more appropriate. Also known as export finance, a further layer is added to the process. Invoices are sold to a factoring company as usual (the export factor); however, they trade with an import factor in the other country (who chases the debt more efficiently due to local business knowledge). As international trade continues to increase and benefit all parties involved, export finance is becoming a more popular cash flow solution and is well supported by banks and governments.
Other popular cash flow solutions
Factoring isn’t the only cash flow solution; other options include:
This cash flow solution differs from debt factoring in that the customer is not aware that a third party factor is involved. As your business has full control of debt collection, customer contact and record keeping, it is more suited to companies with well-established and well-resourced finance departments.
A means of financing from rented goods and hire contracts, such as TV rental or car hire. These contracts represent a future income and can be sold to a third party for instant funds.
Contractual debt finance:
A loan to raise working capital for businesses (often in construction) that trade via long-term contracts rather than invoices.
A short-term loan to cover staff wages during cash flow problems (waiting for clients to pay). Often the 30-day payment terms of an invoice are just too long to cover contractual employee wages, so payroll finance can bridge that gap.