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Invoice Financing

  • Invoice financing is when a company borrows money by using its unpaid invoices as security.
  • Invoice financing can be used by a business to increase cash flow for operating purposes or to accelerate development and investment goals.
  • Invoice financing is often handled in a way that customers of the borrowing company are unaware of the arrangement, or it can be expressly managed by the lender.

Invoice factoring and invoice financing allow companies to take out a short-term loan against unpaid invoices.

These financing methods make it easier for businesses to pay staff and suppliers, improve cash flow, and even reinvest in the business without waiting for customers to pay their bills in full.

As unpaid invoices are used as collateral, companies pay the lender a certain portion of the invoice amount as a fee for taking out the loan.

With invoice financing businesses can overcome the challenges that come with slow-paying customers and difficulties in acquiring other types of business loans.

How Invoice Financing Works

When a company sells services or goods to a large customer, such as a wholesaler or retailer, it is usually on credit. This means the buyer is not required to pay for purchased goods or services right away.

The customer is issued an invoice reflecting the total amount owed as well as the due date of the bill. When a business offers credit to its customers, it can tie up capital that could have been used to invest or expand its operations.

Businesses may choose to use invoice financing or invoice factoring to finance outstanding accounts receivable or to support short-term liquidity needs.

Invoice financing is a type of short-term financing provided by a lender to the customers of the company in exchange for outstanding bills.

A business sells its accounts receivable to increase its available cash flow and working capital, which provides the company with quick funds for business expenses.

What Is Invoice Factoring?

There are multiple ways to structure invoice financing, with the most prevalent being factoring and discounting.

Through invoice factoring for small business, a business can sell its outstanding (unpaid) invoices to the lender, and in turn, the lender may pay the company around 70% to 80% of the invoices’ eventual value upfront.

If the lender is paid in full for the invoices, it will send the remaining 20%-30% to the business. The lender will also collect fees and/or interest for the loan.

One downside of this approach is that customers will often be informed of the agreement because the lender receives payments from them. This may reflect adversely on the company.

Note: With a typical APR of around 15%-35%, business invoice financing has a higher interest rate than traditional bank loans. However, it offers a good short-term solution if most of a business’s short-term assets are tied to accounts receivable.

Another financing option is invoice discounting. This is similar to invoice factoring with one caveat. Invoice discounting companies collect payments from the business rather than the customer, which means that customers will not know about this agreement.

With invoice discounting, a business can get a loan from a lender up to about 95% of the outstanding invoice amount. As soon as the company’s customers pay their invoices, the company can repay the loan, with interest and fees.

Invoice Funding vs Invoice Factoring

Invoice FundingInvoice Factoring
Borrowing money against your outstanding accounts receivables.Factoring company purchases the accounts receivables from you.
You retain full control of collections.The factoring company takes over collections.
When you collect payments you repay the lending company, plus fees.When the full amount is collected you are paid the difference.

How Invoice Financing Benefits Lenders

Invoice financing benefits lenders too. Unlike offering a line of credit, which may be unsecured and provide the lender with little recourse if the business fails to repay what it borrows, invoices serve as collateral for invoice financing.

The lender also reduces its risk by not granting full invoice loans to the borrowing company. Yet, invoice funding does not eliminate all risks because the customer may never pay the invoice.

This would need a time-consuming and costly collection process involving both the bank and the company receiving invoice financing from the bank.

Applying for Invoice Financing

Applying for invoice financing, invoice loans for small businesses, or invoice factoring, is relatively simple and uncomplicated, especially compared to other small business finance options.

Tip: If your chosen lender or financing company provides the option of applying for invoice financing online, the process will be even faster. 

The financing firm, like small business loans lenders, will have many requirements, but outstanding debts will be the most crucial component.

Others may review your personal and/or business credit, as well as your company’s financial statements.

It is essential to inquire before you start the process, so you know where you have the best chance of getting approved.

Some lenders are willing to loan to small businesses that don’t have a healthy credit score. Others focus specifically on younger startups, so it’s important to research the available options.

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Sources

Lorien is the Country Manager for Financer US and has a strong background in finance and digital marketing. She is a fintech enthusiast and a lover of all things digital.

Financial information reviewed byRoss Loehr - CFP®, MBA
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Last Updated: July 19, 2022

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