What is Invoice Financing?
Invoice financing is a way for businesses to borrow money against the amounts due from customers. Invoice financing helps businesses improve cash flow, pay employees and suppliers, and reinvest in operations and growth earlier than they could if they had to wait until their customers paid their balances in full. Businesses pay a percentage of the invoice amount to the lender as a fee for borrowing the money. Invoice financing can solve problems associated with customers taking a long time to pay as well as difficulties obtaining other types of business credit.
Invoice financing is also known as "accounts receivablefinancing"or simply"receivables financing."
Understanding Invoice Financing
When businesses sell goods or services to large customers, such as wholesalers or retailers, they usually do so on credit. This means that the customer does not have to pay immediatelyfor the goods that it purchases. The purchasing company is given an invoice that has the total amount due and the bill's due date. However, offering credit to clients ties up funds that a business might otherwise use to invest or grow its operations. To finance slow-paying accounts receivableor to meet short-term liquidity, businesses may opt to finance their invoices.
Invoice financing is a form of short-term borrowing that is extended by a lender to its business customers based on unpaid invoices. Through invoice factoring, a company sells its accounts receivable to improve its working capital, which would provide the business with immediate funds that can be used to pay for company expenses.
Key Takeaways
- Invoice financing allows a business to use its unpaid invoices as collateral for financing.
- A company may use invoice financing to improve cash flow for operational needs or speed up expansion and investment plans.
- Invoice financing can be structured so that the business' customer is unaware that their invoice has been financed or it can be explicitly managed by the lender.
Invoice Financing From the Lender's Perspective
Invoice financing benefits lenders because, unlike extending a line of credit, which may be unsecured and leave little recourse if the business does not repay what it borrows, invoices act as collateral for invoice financing. The lender also limits its risk by not advancing 100% of the invoice amount to the borrowing business. Invoice financing does not eliminate all risk, though, since the customer might never pay the invoice. This would result in a difficult and expensive collections process involving both the bank and the business doing invoice financing with the bank.
How Invoice Financing is Structured
Invoice financing can be structured in a number of ways, most commonly via factoring or discounting. With invoice factoring, the company sells its outstanding invoices to a lender, who might pay the company 70% to 85% up frontof what the invoices are ultimately worth. Assuming the lender receives full payment for the invoices, it will then remit the remaining 15% to 30% of the invoice amounts to the business, and the business will pay interest and/or fees for the service. Since the lender collects payments from the customers, the customers will be aware of this arrangement, which might reflect poorly on the business.
As an alternative, a business could use invoice discounting, which is similar to invoice factoring except that the business, not the lender, collects payments from customers, so customers are not aware of the arrangement. With invoice discounting, the lender will advance the business up to 95% of the invoice amount. When clients pay their invoices, the business repays the lender, minus a fee or interest.
FAQs
Invoice financing is a credit facility that allows a business to borrow money using high-value unpaid invoices as collateral. This way, you can get the funds you need to meet immediate cash flow requirements to purchase inventory, repay dues, pay vendors or employees, meet marketing expenses, repay debt and more.
What is the difference between invoice financing and invoice factoring? ›
Both invoice financing and factoring let business owners collect invoice payments upfront without having to wait to receive payment from a client. However, unlike invoice factoring, invoice financing creates a relationship between the business and the lender (instead of between the lender and the client).
What is another name for invoice financing? ›
Invoice financing, receivables financing and invoice discounting, are terms often used interchangeably as they share many characteristics. For example, these facilities accelerate a business's cash flow, allowing them to pay employees, suppliers, and other expenses faster.
What is the difference between invoice financing and letter of credit? ›
Both invoice factoring and invoice discounting are sub-forms of invoice finance. By contrast, letters of credit are provided by a banking institution and outlines that they guarantee payment to a seller on behalf of a buyer should all the terms and conditions of the letter be met.
Is invoice financing risky? ›
Default risk in invoice factoring refers to the possibility that the client whose invoices are being financed might fail to pay the outstanding invoices. This risk holds significant importance for factoring companies as it directly affects cash flow and profitability.
What are the benefits of invoice finance? ›
What are the benefits of invoice finance?
- Improve Cashflow: Perhaps the most immediate advantage, invoice finance can boost your cashflow and free up funds. ...
- Flexible Funding: ...
- Quick Access and Fewer Limitations: ...
- Less Risk to Assets: ...
- Better Purchasing Power:
A company may use invoice financing to improve cash flow for operational needs or speed up expansion and investment plans. Invoice financing can be structured so that the business' customer is unaware that their invoice has been financed or it can be explicitly managed by the lender.
Is invoice financing good? ›
Invoice is suitable for many small or medium-sized companies with B2B customers as it lets businesses get paid faster, sometimes within 24 hours, as they receive a large percentage of each invoice as soon as it is raised, using their unpaid invoices as the basis for a loan or an advance.
Is invoice financing easy to get? ›
Because invoice financing is backed by your invoices, it can be easier to qualify for compared to other types of business loans. Lenders typically consider your customers' payment history when evaluating applications, meaning you may still be able to qualify if you're a startup or have bad credit. Fast to fund.
What is the interest rate for invoice financing? ›
Invoice financing interest rate is typically between 7% to 12% p.a. For some non-bank alternative lenders, invoice financing interest could be between 1% to 3% per month.
Professional and business services providers who could benefit from invoice discounting and factoring include architects, engineers and legal firms, as well as companies in the financial sector. When a company is in difficulty, sometimes a process of financial and/or operational restructuring is needed.
What is the difference between PO and invoice financing? ›
Businesses that sell tangible goods opt for purchase order financing before a specific product is sold. Any business that sells products or services uses invoice factoring once the invoice has been dispatched. Businesses can access a large sum of money based on their number of purchase orders.
What is invoice financing also known as? ›
Invoice financing - also known as 'invoice factoring' or 'accounts receivable financing' - is a collective term for financing based on outstanding invoices. Invoice financing allows Suppliers (Exporters) to improve cash flow by receiving advances from a third-party finance provider against unpaid invoices.
What is the difference between invoice financing and factoring? ›
In invoice financing, the customer (you) will still be in control of your collections. On the other side of the equation, factoring an invoice requires you to sell it to a factoring company, which gives them full control over collections.
What is the difference between invoice financing and discounting? ›
The most notable difference between invoice factoring and invoice discounting is who is in control of the sales ledger, who takes responsibility for collecting payments, and the level of confidentiality involved, but there are other notable differences to consider.
Who uses invoice financing? ›
Professional and business services providers who could benefit from invoice discounting and factoring include architects, engineers and legal firms, as well as companies in the financial sector. When a company is in difficulty, sometimes a process of financial and/or operational restructuring is needed.
