By Nemira Palaimienė, Chief Strategy & Growth Officer at CapitalBox
Take it from someone who’s an expert on the subject: invoice factoring is a much misunderstood aspect of contemporary financing strategies. Sometimes we refer to it as “making money out of money,” but in more specific terms, it’s a way to accelerate your cash flow without running right into debt. Invoice factoring or similar purchase of receivables product (depending on country’s regulatory environment, customer habits, etc.) entails selling existing customer invoices to a third party, which pays you for the invoiced amount (minus a factoring fee), and then collects the money directly from the invoiced customers.
In some ways it sounds simpler than it actually is. Controlling, tracking, and transferring information about the invoices can actually be very chaotic, and it doesn’t take much to send an Excel spreadsheet into conniptions, to say nothing of the time even partially manual data entry requires. Recommending invoice factoring to SMEs isn’t as simple as just saying that it’s a good strategy. It needs to be a workable one too, in which the benefits still outweigh the time and effort required to implement and sustain it.
Factoring’s undeniable advantages
Convincing SMEs that invoice factoring is worth it in the first place begins with an understanding of the broader financing climate right now. SMEs throughout Europe remain underfunded in the billions of euros, often due to their lack of sufficient collateral in the early stages, and because larger financial institutions are hesitant to loan them the capital they need to actually grow, not just survive. The alternative lending industry at large has enjoyed some of the success that it has because it has set itself up to address that gap, and loaned to SMEs who have struggled to acquire capital from bigger banks.
Considering this it’s not altogether surprising that alt lenders are leading the charge with factoring integration. In searching for more ways and methods to not only fund SMEs but fund these companies effectively, factoring is a natural choice. It’s also one that requires smart tech in order to work effectively. Alt lenders that have already made their name through melding smart technology with effective lending are uniquely positioned to make factoring work for SMEs.
From a financial sense, factoring is ideal. It doesn’t disrupt the flow of a company’s goods or services to customers. It improves cash flow. In having the bulk of your invoices paid almost immediately and collectively, cash flow becomes predictable. It takes chasing invoices off of a company’s already long to-do list. It’s also cheaper and easier than a standard bank loan; debt management becomes a non-issue. Invoice factoring fees are often far cheaper than credit control staff, saving SMEs money and time on personnel. It bears mentioning, however, that factoring is only suited to SMEs with a fair amount of invoices and customers. Many early stage SMEs don’t have this right from the starting line, but as soon as they do, it’s a valid option.
Once it becomes a valid option, SMEs should consider it in tandem with credit insurance, which shores up trust and security for all parties and can even lead to better financing terms. Credit insurance helps businesses optimize their cash flow, which is already accelerated by how factoring provides immediate liquidity against receivables. With credit insurance minimising the risk of non-payment, the factor may even be willing to advance a higher percentage of the receivables’ value. This increased advance rate then enhances the working capital available to the business, enabling it to invest in growth opportunities, meet operational expenses, or reduce debt. It’s the best possible outcome and protection for everyone involved.
Making factoring worth it
The simple fact that an SME needs enough invoices and customers to make factoring worthwhile and effective brings us to a crucial point. Accurate data entry of lots of invoices (and customers) requires time and concentration. Leaving it up to an intern and a spreadsheet is a totally unworkable strategy.
This is where great automation comes in. Factoring only works if the system used to track and sell invoices does too. This system needs to be easy to integrate and easy to use, and certainly not require hours of manual data entry. Legal compliance also matters here – another place where automation can provide crucial assistance. With human error compensated for and manual data entry all but eliminated, factoring becomes not only useful but genuinely desirable.
So much of the discussion around funding SMEs revolves around cash flow. That’s not a surprise – cash (flow) is king for early stage and growing businesses. Factoring takes debt out of the equation in a way more standard lending simply does not. Done correctly, and done with the right system, factoring is a boon for SMEs.
What factoring can’t do is solve all SMEs’ cash flow problems or the greater lending gap in one go. It doesn’t work for SMEs with the kind of very specific focuses that entail smaller customer bases. It’s always going to entail a factoring fee from the third party that purchases the invoices – this isn’t free money.
But for the SMEs it does work for, this is one more way to move the entire economic sector forward. It’s one more way to get around the hesitancy of big banks when it comes to SME lending. And it’s already a proven strategy. Implementing it with the smartest possible automated system is a real way forward, and SMEs should take it.
