Businesses are forced to manage diverse and unexpected cash flow stresses on a continual basis. These can come in the form of one-time cash flow disruptions like equipment malfunctions, unexpected tax penalties, or legal fees, or they can be more chronic issues, like late client payments, declining sales, or rising supply costs. While the long-term solutions to each of these is different depending on your business’ particular needs and the circumstances involved, the short term problem is universal: Businesses need capital to operate.
Invoice finance is a very popular way for businesses to come up with the funds they need to manage shortfalls. This is both because of ease of access, and because it doesn’t negatively impact a business’ future ability to secure funding for growth.
Broken budgets unnecessarily prevent growth
Budget shortfalls are frustrating for business owners, but even temporary cash flow problems are dangerous for businesses. It’s not uncommon for businesses to simply delay outgoing payments to suppliers until revenues come in, but this kind of behavior can lead to strained relationships, and can even jeopardise supply lines. Suppliers who don’t trust their partners will be less open to negotiating competitive deals, and may be wary of scaling up operations to support your business’ growth.
Cash flow interruptions can also force businesses to abandon non-essential projects, which can interfere with growth by interfering with marketing campaigns, and research and development. Not only are those businesses then forced to absorb the sunk costs involved, but they’ll be forced to start over after they financially recover, delaying their growth plans, and letting time-sensitive growth opportunities slip away.
Invoice finance is an ideal cash flow regulation tool
Invoice finance is designed to help businesses get the cash they need as soon as they need it. Unlike a traditional loan, which can take weeks or months to process, invoice financing allows businesses to get the cash they need in a matter of hours. Moreover, it’s a type of off-balance sheet financing, meaning that it doesn’t involve taking on any debt.
Get cash without impacting your debt to equity ratio
Unlike invoice financing, loans affect your business’ balance sheet. When you borrow money, your debt level rises, which impacts your debt to equity ratio. A business with a high debt to equity ratio is less likely to qualify for future financing, and may also be less attractive to investors. Invoice financing works differently.
Instead of borrowing money, businesses can effectively give themselves an advance. This is done by trading an outstanding invoice for cash. The financier issues most of the value of the invoice up front, collects the payment for the invoice when it’s due, and then pays out the remaining funds, minus a pre-arranged fee. Instead of taking on debt, the business simply trades an existing asset—the customer’s debt—for cash.
Invoice finance can accelerate growth
Besides simply providing funds in a pinch, using invoice finance to generally access revenues sooner can increase your business’ buying power. This is because invoice finance can shorten your business cash conversion cycle. The cash conversion cycle is the amount of time it takes a business to turn a profit on any given investment. Specifically, it’s the amount of time a business has to wait between paying suppliers, workers, and other operating costs, and collecting the revenues that those expenditures produce. The sooner those revenues are collected, the more quickly the money can be invested again to restart the cycle.
The length of a business’ cash conversion cycle has enormous implications for its profitability. As a rudimentary example, a business with a 10% profit margin and $1 million to invest in its operations could produce up to $100,000 in profits with each cash conversion cycle. If that cycle is 90 days, the business might make a total profit of $400,000 per year. An identical competitor using invoice financing, however, won’t need to wait for clients to pay their invoices, and might be able to shorten that cycle to something like 60 days. That competitor could invest the money more often in the same time period, earning up to $600,000 in a year.
Other alternative financing tools can further shorten a business’ cash conversion cycle, potentially reducing it to 0. At this point the business’ operations are fully financed, so businesses can pay for inputs after the respective outputs are already sold. At this point, growth is no longer limited by the amount of working capital the business can invest in itself. In effect, invoice financing (and other financing tools like it) help businesses to not only manage cash flow interruptions, but also to vastly improve their growth potential.