What is invoice finance? Pros, cons and alternatives to consider

If you’re thinking about invoice finance for small businesses, it’s helpful to understand the different options available, as well as the pros and cons of using these financing tools.

This guide to invoice finance in Australia gives an overview of how business invoice finance usually works, including the advantages of invoice finance and the common pitfalls. We’ll also touch on how alternative tools - like Wise Business - can help you keep down your operational costs and reduce your reliance on short term measures like invoice financing.

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What is business invoice financing?

So, let’s start with a definition. What is invoice finance?

Business invoice financing is a way to get funds quickly, when you are owed money by customers who have received an invoice, but are not yet due to pay.

To give an example, you may provide a service for a client, and issue an invoice with 30, 60 or even 90 day payment terms. That means you have to wait a month - or significantly more - to see your money. In the meantime, you still need to buy additional supplies, pay team members, cover your utilities and rent - which can make this wait feel painful. That’s where invoice finance for small businesses comes in.

In fact, there are usually 2 types of business invoice financing you may consider for your Australian business, known as:

• Invoice finance factoring
• Invoice finance discounting

These both work differently, but have a similar immediate effect - allowing you to get access to funds, with loans or credit secured against the value of invoices you’re owed. We’ll look at how they work in more detail, next.

This guide is for information only and does not constitute advice - if you need help with accounting, finance or tax for your Australian business, take professional advice.

Invoice finance factoring

In invoice finance factoring you’ll sell your unpaid invoices to a third party, known as the factor. This third party provider now owns your invoice, and takes over responsibilities for chasing up customers and receiving the payment when it arrives.

In return for giving control of your invoice to the factor, you’ll be paid an agreed percentage of the invoice amount - usually about 80% of their value. Once the invoice is settled to the factor, they’ll pay you any funds remaining under the terms of your agreement - fees will be deducted.

Invoice finance discounting

In invoice finance discounting you’ll essentially use an unpaid invoice, or invoices, as collateral to take out a loan from a business working capital service. You retain ownership and control of the invoices, so you’ll be responsible for following up and receiving the payment from the customer when it comes due.

The provider you choose for invoice finance discounting will offer you a loan based on their assessment of your creditworthiness and cash flow, taking into account the unpaid invoices. You’ll be given a credit line or a lump sum reflecting their offer - and once your payment arrives from your customer you must repay the loan or any credit used. Your final bill will include fees, interest or other costs as agreed under the terms of your agreement with the provider.

What are the advantages of invoice finance for Australian businesses?

So why consider invoice finance? Here are a few of the advantages of invoice finance for Australian businesses which may sway your decision:

• You can access funds quickly, to support cash flow, buy supplies or cover unexpected expenses
• Under invoice factoring you won’t need to follow up customers to chase payments if they’re late
• With invoice discounting providers may offer better terms based on the invoices than they would using only your credit score, depending on the situation

And what about the downsides of invoice finance?

Of course, invoice finance has its downsides, too. Here are some counterpoints worth thinking about if you’re considering it:

• You’ll pay a fee, interest or other costs in all cases
• You may ultimately bear the costs if the customer defaults entirely
• With invoice factoring you lose control of your relationship with the customer, which can damage your brand
• Relying on invoice financing can mean there are underlying issues in your cash flow arrangements which you need to fix

Effective ways to manage your business finances

Relying on invoice financing could be a sign of issues worth examining and correcting in the way you’re managing your business finances end to end. If you’re looking for ideas and solutions, here are a few to consider:

Use accounting software which helps with cash flow management

If you’re not using an accountant for your business, cloud accounting software can be a good way to bridge the gap and make sure you’re able to keep on top of your business finances effectively. There are fees to pay for most cloud accounting solutions, but many providers have free trials or deep discounts for new customers, which allow you to test them out.

You’ll usually find that accounting software offers analytic tools which can help you to visualise and manage your cash flow, which may mean it’s easier to manage.

Build a reserve fund

As soon as possible, start to build a reserve fund for when emergency payments arise, or when you spot a great deal and want to spend for your business immediately. While this isn’t always easy for newer businesses, it’s worth considering, and building into your business plan if you’re still pre-launch or in the early days of operation.

Having a reserve fund not only means you won’t need to rely on invoice finance, you could also use it to take advantage of opportunities as they arise, without needing to worry too much about where to find the cash.

Manage existing debt as effectively as possible

If the issue driving your reliance on invoice financing is existing business debt, it may be time to talk to your bank or another professional about ways to manage or structure your debts to avoid short term pain and get back to smooth operation.

There’s no easy solution if your company has debts which are making life tricky, but tackling the issue head on, and as early as possible, will mean you have the best chance of resolving the issue.

Minimize the costs of international transactions with a provider like Wise Business

If the costs of managing payments - particularly international payments - is causing you a headache, consider specialist providers like Wise Business which can help drive down fees when you receive, send or exchange currencies.

Wise offers powerful international business accounts which allow you to exchange currencies at the mid-market rate with low, transparent fees and no surprises. You can hold 40+ currencies in your account, allowing you to hedge against fluctuations in the exchange rate if you buy from overseas suppliers. You can also receive payments in foreign currencies with low or no fees, to connect with international customers more effectively, and grow your business beyond borders.

Wise Business helps streamline overseas business payments without foreign transaction fees, saving up to 3x compared to other providers.

• Free to register — Send money to 140+ currencies with no hidden exchange rate markups
• Make up to 1,000 transfers at once with the Wise batch payments feature
• Fast, low-cost payouts to customers, freelancers, employees, investors, and suppliers globally
• Automate invoice payments, recurring transfers, and international payroll
• Fast and fully secure payments through Wise, even for large amounts

Tired of hidden fees and complex processes when making overseas payments?

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Ensuring the right use of Invoice financing

Invoice finance is a way to release cash quickly from invoices which may not be due for 1 - 3 months. However, there are costs and risks involved, so it’s not a strategy usually relied on.

This guide gives you an overview so you can consider if it’s right for you - and while you’re thinking about managing your business finances more effectively, take a look at Wise Business to help you connect with customers, suppliers and contractors overseas with low or no fees and the mid-market exchange rate.