It goes without saying that being able to manage your cash flow efficiently is up there with the most important keys to running a business, and this is something that's true regardless of how large your company is.
Despite how essential it is, though, it's obviously easier said than done to ensure that you're always on top of your business finances. Especially if you're a small business owner or freelancer who perhaps has fairly sporadic profitable periods or seasons.
Though traditional business loans are generally the go-to for larger businesses with fairly impeccable credit scores, one of the newer methods that are gaining popularity is invoice discounting, which is essentially just a way you can gain access to some of the funds you have tied up in unpaid invoices.
Naturally, this can be a lifesaver in terms of improving liquidity within your business, but it's not without its fair share of disadvantages, too.
So, throughout this article, we'll be taking a closer look at what invoice discounting actually is and what pros and cons you can expect from it — covering things like the impact it has on businesses (especially those who deal with a lot of commercial invoices and credit sales).
Understanding Invoice Factoring
It might sound a bit more convoluted than what it actually is, but invoice financing essentially revolves around commercial invoices — i.e. the formal records of credit sales with the total amount due and payment terms specified.
Credit sales are naturally pretty commonplace for most businesses, especially anyone who deals mostly in B2B transactions.
Having said that, the strain it can end up having on your business's cash flow can obviously become a problem pretty quickly, but that's when invoice discounting comes into play. Basically, allowing you to leverage any outstanding invoices you have so you can access cash immediately.
This is achieved through an invoice discounting facility, which is essentially where a financial institution provides a certain amount of whatever your invoice value is upfront.
Advantages and Disadvantages of Invoice Discounting
| Advantages of Invoice Discounting | Disadvantages of Invoice Discounting |
|---|---|
| Raising Fast Cash and Improving Cash Flow ✔️ Obviously, no one likes having to wait a while to get paid, so the swift access to cash you've gained from the funds tied up in accounts receivables is an obvious benefit. Not only is this kind of cash injection important for covering any kind of emergencies or unforeseen expenses, but it also means that your business now has a lot more working capital — covering things from immediate expenses to opportunities for growth. | Cost Implications ❌️ It's fairly hard to turn your nose up at immediate access to cash when you're running a business, but this type of convenience tends to come at a cost. In this case, the invoice discounting companies you'll be dealing with will naturally charge a fee for their services, which is typically just a percentage of the total invoice value. Now, this can obviously start stacking up pretty heavily over time if you start becoming too reliant on this method, so you may be better off with a more traditional bank loan if you're looking for something with slightly lower interest rates. |
| Maintaining Customer Relationships ✔️ Generally speaking, the vast majority of traditional bank loans out there make you assign all of your assets as a form of collateral to get the money, but invoice discounting gives you far more control. Since the business continues to handle the collection of payments like normal, your customers aren't even aware of the financial arrangement, so there's no knock on your client-vendor relationships. | Unsecured Nature of the Loan ❌️ Invoice discounting is essentially just an unsecured business loan, meaning it doesn't require you to put up specific assets as collateral. |
These kinds of business loans are usually pretty helpful in preserving your assets, but they also pose a risk for the invoice finance provider. In the event of non-payment by customers, the invoice discounting company may have limited recourse to recover the funds, which can definitely lead to complications in your relationship with each other.
