When a business is short on cash flow, directors will often turn to multiple sources in a bid to quickly inject money into the business as a way of providing temporary relief. This short-term form of lending is known as invoice financing or factoring.
This type of lending allows businesses to use outstanding invoices or accounts receivable as collateral against borrowing. When it comes to borrowing against invoices, there are two types of finances with small differences:
- Invoice Financing/Discounting – In this case, the company maintains control over their sales ledger and collects the money from clients directly.
- Invoice Factoring – The factoring company takes control of the sales ledger and collects money from clients on behalf of your business.
Despite the differences, the risks and consequences for your business are mostly similar. Although they may seem like a good idea at the time, this type of borrowing rarely brings about any improvement in the business.
This may be due to many companies only turning to invoice factoring or financing when they are already dealing with more serious cash-flow issues. There is also an extremely high borrowing cost compared to other types of finance.
When speaking to any of the major lenders in this sector, you will be informed of all the ‘positives’ associated with borrowing using these facilities. These sales pitches should be taken with a pinch of salt as they will likely not mention the significant downsides, which include:
- Cost of borrowing – Due to the fact that there are charges on each loan, along with interest, invoice factoring and financing can be more costly than traditional lending. It is seen as a relatively high-risk form of lending and as a result, can see you paying heavy factoring fees, plus interest of up to 50% or more. Ultimately, this means that when you do receive the money for the invoice, you could be making a loss on that sale.
- Tight payment schedules – The longer you borrow the money for, the higher the ultimate cost will be. This means that your customers need to pay their invoices on time. Any delay could be extremely costly for your business. Again, this could eliminate any profits and begin a vicious cycle where the money you are receiving is not covering your invoices. Once you fall into this trap, it will be next to impossible to recover.
- Personal guarantees – The biggest risk of any invoice financing or factoring arrangements is the personal exposure that they will inevitably bring. Due to their nature, you will almost never find an invoice finance provider that does not require a director to sign a personal guarantee. If a payment is missed, or your business enters insolvency, you will become personally liable for the outstanding amount, plus additional costs and fees.
The Alternatives
The above are just a few of the negatives of using invoice financing or factoring for your business. As with any lending, there are potential risks. However, with invoice financing the risks almost always outweigh the benefits. It is often the beginning of a vicious cycle that can leave you failing to ever catch up on payments. It’s important to note, there are always better alternatives available.
If your business is at the stage where you think you may need to utilise invoice finance or factoring, you need to speak to business experts. There may be a more suitable route for recovery that does not involve costly borrowing. Often more informal agreements can benefit all parties.
But this is not a ‘DIY’ process, it is important to consult experienced debt experts to get the best possible options for you and your business. If you would like to speak to us about your best options, you can call us on 0333 305 4331, request a call-back below or join our live chat to speak to an advisor today.
