Businesses of all sizes struggle with cash flow. For SMEs, positive cash flow can provide a sustainable lifeline where negative cash flow can lead to problems. Even extremely profitable businesses can struggle with cash flow.
High operating costs, low profit margins, lack of credit and slow paying customers can add stress to the cash flow of any enterprise. Business managers that understand this harsh reality can take steps to ensure that their cash flow remains manageable.
Three Ways to Improve Cash Flow
Improving cash flow is possible for every business. Each option comes with different levels of risk.
1. Secured Loans
Secured loans have served businesses with good to excellent credit histories and significant assets for years. Under this type credit arrangement, the company posts its fixed assets, like equipment and real property, as collateral for a secured loan. Of course, the risk is default. If the enterprise cannot comply with the terms of the loan, the lender can take title to the assets and liquidate them, thus closing the business. The enterprise’s credit rating and the nature of the assets are two important criteria for this type loan. Small business owners may also be asked to sign a personal guarantee.
2. Invoice Discounting
More and more SMEs are gravitating to invoice discounting (also known as invoice financing) as a means to improve cash flow. Invoice discounting is a financing process that allows the enterprise to assign its invoice payments to a lender who offers the enterprise a discount in return for 90% of the unpaid invoices.
An enterprise with £10,000 in unpaid invoices would have access to £9,000. The business would only pay the discount on the amount accessed. The discounted amount is available immediately, with no more waiting for slow pay clients.
3. Invoice Factoring
Invoice factoring is another option for SMEs. Although it has similarities to invoice discounting, there are significant differences. With invoice factoring, the business relinquishes the entire invoicing and collection rights to the lender for a percentage of the invoices.
The lender will carefully scrutinise the borrower’s clients and their payment histories. If the borrower agrees to this type of financing, the company has no exposure to bad debt. The approval process takes much longer than with invoice discounting because the credit of the borrower and the credit of the individual clients must be considered. Longstanding client relationships are necessary for this type financing.
Comparing Invoice Discounting and Invoice Factoring
Invoice Discounting and Invoice Factoring are two financing options that fall under the general heading of Invoice Finance. As such, they represent two viable ways to raise cash using the value of invoices. One significant advantage of these options is that they rarely contain the personal guarantees that other types of small business loans contain.
Under the general umbrella of Invoice Finance, invoice discounting and invoice factoring both can improve cash flow but they have important differences that business managers should understand.
With Invoice Discounting, the borrower retains responsibility for managing, invoicing, sales promotions and collection payment. Also, customers often appreciate the fact that their accounts are private and not accessed by a third party.
Invoice Discounting is more confidential than Invoice Factoring. The supplier is still the driving force and responsible for the sales ledger. Invoice Discounting is normally provided where goods and service are sold to another business under defined credit terms. Lenders may include protection about bad debt.
Because the process is quite straightforward, Invoice Discounting is relatively simple to arrange and implement.
With Invoice Factoring, the lender will closely examine the relationship and credit history of all the customers that are invoiced. This can take a good amount of time, but our experts at NGI Finance can help you every step of the way.
Companies that provide Invoice Factoring take responsibility for invoicing and invoices are issued in the lender’s name. Therefore, the lender receives and deposits all payments.
With Invoice Discounting, the borrower sends the lender a daily sales book rather than copies of invoices. The enterprise provides all invoicing, sales ledger and collection responsibilities. The customer never knows the enterprise is using the invoices as security. Also, the customer contact information is not conveyed to the lender. This is not the case with Invoice Factoring where the lender handles both invoicing and collections and can often prove to be not very flexible with collection policy.
With Invoice Factoring, the lender receives payment. With Invoice Discounting, the borrower receives the payments and deposits them into a dedicated bank account. The Discounter then pays the borrower the balance less agreed charges. The charges consist of a service fee and an interest charge. These fees should be negotiated in advance of the Invoice Discounting agreement.
Invoice Discounting has served many SMEs well during the recession when new credit standards have become more stringent. This is a viable cash flow alternative for many UK SMEs.