Increasing number of small businesses using finance to cover cash flow

February 21st, 2020     Business news, Improve Your Business

Around 37 per cent of small businesses that made successful finance applications in the three months to December 2019 used the capital to plug a gap in cash flow, a major study has revealed.

The finding forms part of the Federation of Small Businesses’ (FSB) new quarterly Small Business Index.

According to the report, “managing cash flow” is the most common use for external finance among small firms, with just 23 per cent raising capital to “update equipment”.

Even fewer businesses, meanwhile, used funds for expansion of their businesses (16 per cent), while just two per cent used funds for recruitment.

With figures suggesting that cash owed to small firms doubled to £23.4 billion in 2019, the use of external finance to cover gaps in cash flow – known as invoice finance – is becoming increasingly common, says FSB National Chairman Mike Cherry.

He added: “It’s troubling that so many external finance applications are driven by cash flow concerns. This really shouldn’t be the case – you wouldn’t dream of doing your weekly shop and telling the cashier that you’ll pay for it in 100 days, but corporations take this approach to small businesses in droves.”

So, how does invoice finance work? And is it even good for business?


What is invoice finance?

Invoice financing is a way of raising capital against the cash owed to you by customers. It works by businesses selling their accounts receivables (invoices) to a financier for a percentage of their value. The industry average varies from between 95 to 98.5 per cent.

With the ability to release capital almost instantly, rather than wait for customers to pay up in accordance with your agreed payment terms, the major benefit of invoice financing is improved cash flow. This, of course, enables you to capitalise on investment and growth opportunities, pay staff on time, and ultimately benefit your business in the long term.

Invoice financing, however, is a short-term solution. While providing instant relief, an affordable overdraft facility or bank loan may be more suitable for your circumstances. Also, note that invoice financing is only available if your clients are business customers.


The alternatives

While invoice financing can be hugely beneficial in covering temporary lulls in cash flow, businesses who regularly suffer from liquidity should look towards permanent solutions.

Unfair payment terms and conditions, for example, are among the most common cause of disrupted cash flow for small businesses. It is therefore advisable to renegotiate with suppliers and clients to reach new agreements that work for both businesses. Some clients find that incentivising early payments – through the promise of discounts, for example – can keep cash flowing.

Technology is also a powerful tool in your business arsenal. Thanks to the latest innovations, small businesses can now efficiently and affordably carry out credit checks on prospective customers to make better-informed decisions about doing business with them. Digital invoicing software, meanwhile, can automatically chase clients and notify you when payments are late.

Additionally, small businesses who enable Stripe payments – an Xero-compatible digital payments processor – on invoices are paid, on average, 15 days faster than those who don’t.

To learn more about how accounting software can help you save time and money and improve cash flow, read our new blog: cash flow apps that could save your business from a payroll pileup.


About Andrew Price

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