Is Invoice Finance a Credible Alternative to Bank Loans?
Invoice finance (IF) is not considered a credible source of finance among some business owners because of its relatively high cost and onerous terms. Is this perception justified? Dr P Singh of Cash for Invoices Limited investigates.
What is invoice finance? It is the sale of a company’s sales ledger for cash providing an ongoing source of cash as invoices are issued to customers by the company. The company might retain the collection of cash or transfer this and the associated credit risk, to the funder.
Some conventional IF facilities can impose numerous types of fees and charges, and require security and a commitment from the company to sell its entire sales ledger to the finance company. Some companies offer a refreshing financial alternative, offering to buy just a single invoice and charging as few as just one fee and generally offering a more flexible funding alternative.
What is single invoice finance? As its name suggests, it is the purchase of one invoice for cash from a company. The company does not need to sell any further invoices so single invoice finance can be used by companies to raise cash as they need it. Also, they might not need to provide security such as a debenture or a personal guarantee. Single or multiple IF are effective tools for cash management because they liquidate illiquid assets i.e., they convert debtors into cash. The cash realised can be reinvested by the company in profitable projects or used to pay back expensive debt.
Some borrowers might argue that on an annualised basis, the cost of invoice finance is high compared to a conventional loan. That comparison is like comparing apples to oranges because the two financing instruments work differently. A loan is a continuous source of finance whereas single invoice finance is discrete – providing finance for up to 90 days or less. Annualisation of the cost of invoice finance is not therefore consistent with its use. Though the interest rate on a loan might look relatively attractive, the cost of arranging and administering it must also be factored in, such as the arrangement, commitment, non-utilisation, and exit fees, plus servicing charges and legal costs of documentation. There might also be costs to pursue and recover bad debts, or to pay for credit protection. Invoice finance has its own arrangement and administration costs that might be more or less than a bank loan.
Invoice finance is therefore a credible alternative to a loan because:
it converts a company’s debtors into cash that may then be reinvested to potentially generate positive return for the company.
the company can transfer debtor credit risk.
it avoids using up a bank’s limited credit capacity for a company
it diversifies the company’s sources of funds so reducing its reliance on the banking sector.
companies can use it to raise cash as needed
security might not be needed
