Despite the turbulence created by the global financial crisis, it remains smooth sailing for business growth across Australia.
In 2008, there were 1668610 registered companies, according to the Australian Securities and Investment Commission (ASIC). That’s nearly 67000 more than at year’s end 2007.
While there are plenty of reasons to start a company, there’s almost as many to need financing. The question for business owners is how best to go about it.
Invoice financing, or factoring, is one option that for years has been saddled with the stigma of being the absolute last resort for business finance.
Accountants such as Reckon Accredited Partner Tony Pollard of Amable Management Services Pty. Ltd., in Burwood, NSW, however, say the mentality is shifting.
“Business owners are seeing that it helps keep their working capital under control,” he notes, “particularly as [customers] are now taking longer to pay.”
Others are buying into it as well. The Institute of Factors and Discounters in Sydney estimates annual turnover of approximately $65 billion for 2008 compared with just over $50 billion in 2007 and only $5 billion in 1997.
Invoice financing involves a financial institution or discounter, purchasing the business’ book of debts, typically for those customers who have bought goods or services on credit terms, from the business owner.
The benefit to SMEs is they have immediate capital to expand their business without having to wait for customers to pay the outstanding balance. Accordingly, customers are unaware that a third party is now involved.
Factoring, which is largely synonymous with invoice financing, operates in a similar manner though the sales accounting function is provided by the factor or lender. In this scenario, the third party manages the sales ledger and assumes the risk for all accounts.
Both invoice financing and factoring can be particularly valuable with recent changes to consumer payment terms ─ to 56 days from the standard 30-day period ─ which often leave business owners short on capital and unable to capitalize on growth opportunities.
Through invoice financing, business owners receive cash totalling between 75 and 90 per cent (depending on the lender) of the invoice’s value as soon as it is issued to the customer. The lender’s fee varies from 1 to 3 per cent and the balance of the invoice is paid to the business owner when the customer settles the debt.
The financing is most often used when businesses need to increase their cash flow and/or grow the business. For instance, it allows the SME to purchase equipment instead of leasing it. In addition, it can be valuable when acquiring other businesses, management buyouts or when business owners have limited access to equity.
By improving cash flow, there’s no need to offer early payment discounts and the headaches of chasing tardy customers for payment are removed. Plus, financing costs are tax deductible.
Invoice financing compares favourably with traditional overdraft-style bank funding which tends to set a monetary limit linked to the security value of your property and personal assets.
While the minimum turnovers required to qualify for invoice financing vary depending on the lender, rarely does it make sense for a business owners to use invoice financing if they’re generating less than $100,000 a month. When turnover is less than expected, business owners will likely be subject to steep costs and can often end up paying for money they haven’t yet generated. Also, don’t expect invoice financing to be the remedy for bad debts. Good debtor management is essential throughout the financing process.
The best advice for any SME considering invoice financing is to do your homework and consult your accountant. The latter will guide you on how much funding is necessary, whether invoice financing is the best choice, or if it’s even necessary at all.
Amable Management Services’ Pollard insists on being completely honest with your lender. Don’t make the mistake of glossing over your finances because it will erode trust and lessen the likelihood of the lender’s support if you end up in a tough spot.
Still, be wary of finance offers because as one invoice company executive warns, “There are far too many smoke and mirrors in this business. And when there are lots of mirrors it usually means someone wants to hide something that’s not in your interest to see.”
Gavin Dixon is the CEO of Reckon Limited’s Business Division in Sydney. Reckon is the supplier of QuickBooks and Quicken accounting and financial management software. http://www.reckon.com.au