The Risks of Invoice Financing (and How We Mitigate Them)

Whether it’s factoring or invoice discounting, invoice finance is a safe and secure form of business finance that can inject much-needed cash into your company. As with all business finance, there are certain risks that you need to be aware of.

Working with a specialist broker like Compare Factoring is a sure-fire way to mitigate these risks, as you’ll be fully prepared and informed during your initial search for funders, when you come to select your funding provider, and while your financing facility is up and running.

What are the Risks of Invoice Discounting and Factoring?

In the main, invoice factoring is less risky compared to invoice discounting. With factoring, the funder takes over your credit control and collection process, which offsets some of the risk of advancing your company cash in the first place. Without this direct contact with your debtors, invoice discounting providers take on more risk. As a result, discounting is typically offered to larger turnovers and evidence of a creditworthy customer base.

Let’s break down some of the common risks associated with these two forms of invoice finance, together with some counter-examples based on our expertise in the market.

Risk: Invoice finance leads to lower profit margins

As with any form of business finance, the cash injection from invoice finance comes at a cost in the form of the funder’s fees.

On the other hand, the immediate financial support that invoice finance brings might just be the difference-maker that allows your company to take on new contracts, boosting your turnover in the process.

Let’s look at a working scenario.

Let’s say your business has been asked to fulfil an order worth £10,000 where your profit margin will be 25%. As things stand, your cash flow won’t allow you to take on the order, as your supplier needs to be paid within 14 days but your customer won’t pay you for 30 days.

Rather than turning the new business down, invoice finance is an ideal solution to the cash flow obstacle. If your funder provides 90% of the invoiced £10,000, that’s £9,000 upfront that you can use to pay your supplier on time.

And if the cost of the financing facility is 2% (£200), you’ll still be making a £2,300 profit on the new contract.

Risk: Invoice factoring means giving away control

In the case of factoring, you’ll pass on your credit control operations to the funder. In a sense, you’re losing control over one aspect of your business.

We’d argue that this risk can also be seen as a major positive. By working with a factor, you’ll gain their expertise and guidance on what level of credit is sensible to extend to a prospective or current client. A factor won’t provide funding for a customer they deem to be seriously uncreditworthy, which will help you in your strategic decision-making around new business. It’s in both their and your business’s best interests to avoid such high-risk customers.

On the flip side, your funder can also give you a confidence boost to offer greater lines of credit to customers they deem to be reliable.

Selective invoice finance or spot factoring also give you the opportunity to select which customers/invoices to finance, meaning you can leave any customers with suspect credit histories out of the arrangement altogether.

Even if you have concerns about your customers’ ability to pay their invoices, you can look into bolting bad debt protection onto your facility. This means that if a customer fails, your invoice finance facility will protect you from the bad debt incurred.

Risk: Invoice finance has a stigma attached to it

Historically, invoice finance was sometimes associated with businesses with severe cash flow problems. In the case of factoring, your customers will be made aware of your arrangement with your financier, and this may impact your reputation.

Today, this view seems pretty old-fashioned. Yes, invoice finance offers a valuable solution to businesses facing unstable cash flow. But as well as companies that are just starting up or that are in a turnaround position, invoice finance is also being increasingly used by larger companies that are growing rapidly. With intense growth comes increased costs. By releasing funds from outstanding invoices, wages can be paid and materials can be bought without being stuck in limbo based on your customer payment terms.

Risk: Invoice finance means my customer relationships will suffer

Customers appreciate dealing with you directly. The risk around bringing a third party into the mix is that your business relations will take a hit.

With factoring, this is offset by the funder’s support in helping you chase customer payments. If you’re a growing concern, this administration is a drain on time and resources and better completed by credit control specialists. Factoring may also give your customers an incentive to pay that little bit quicker, as they may find being in debt to a large financial institution more compelling/threatening than owing a smaller business.

With invoice discounting, remember that your customers will be completely unaware of your invoice finance arrangement. Invoice discounting is confidential. Customers will pay into a trust account in your business name, and you’ll retain control over your payment collection process. The rest takes place behind the scenes.

Risk: Invoice finance comes with early termination penalties

Your invoice finance arrangement will most likely include an early termination clause that requires you to repay any money that has been advanced but not yet recouped from the customer.

We can help our clients manage the closedown of a financing facility. Importantly, you do not have to pay a lump sum back in one go. Instead, you can wind down the use of the facility until you have caught up with your borrowing requirements.
Also, it’s worth remembering that you do not need to borrow the full amount available in factoring – but it is there if you need it.

At Compare Factoring, we understand the risks involved in any invoice finance arrangement. We always advise clients to get expert advice on what suits their businesses best and how to get the most out of their funding provider.
Thinking about taking advantage of invoice finance for your business? We can help. Our advice is 100% impartial and 100% free.