What's Invoice Financing?

Invoice marketing is a great way for a business to borrow money from the amounts due. How is that possible and how is it done?

Also known as accounts receivable financing or receivables financing, invoice financing is a method of borrowing against amounts due from customers that allows for business to improve cash flow, pay bills from suppliers, vendors and employees. For some business struggling with customers dragging their feet on paying their invoices, accounts receivable financing can be a solution.

The majority of businesses extend terms to their customers as a courtesy to allow them a certain amount of days to pay their bill. Credit terms can range from fifteen days, thirty days or sixty-day terms. Without immediately having to pay for the goods, customers are entrusted based on credit and good will, and some will almost certainly take advantage of this position. For a company, especially smaller businesses, customers with poor paying records do them no favors, often tying up much needed funds to pay bills and keep day-to-day operations going smoothly.

How Invoice Financing Works

The details of invoice financing leads you to learning about a term called invoice factoring. Invoice factoring is the simplest form of invoice financing - the exchange of accounts receivable to a factoring company for immediate payment on the borrowing business’ behalf. These newly obtained funds can be used for any purpose as the business sees fit: new projects, paying/hiring employees, purchasing new supplies or simply paying for expenses.

Factoring lines is based on sales volume. If your business has a sustainable amount of creditworthy commercial clients, then your lines can increase based on this factor because more sales are being generated.

A company will sell its accounts receivable through invoice factoring to improve on its working capital to a lender via short-term borrowing. Now, the company has immediate funds to work with instead of outstanding invoices awaiting severely delayed payments from its customers.

Invoice financing can be done in a manner so the late paying customer is completely unaware that their specific invoice has been financed as well. Although this isn’t always the case. Sometimes, lenders do the collecting on the business’ behalf, and the customers become privy to the fact that the borrowing company proceeded to finance their invoice. This could reflect poorly on the company’s reputation. 

Businesses can qualify with these guidelines: having commercial clients with upstanding credit, being a business that is free of liens, maintaining good invoicing practices and having invoiced customers for goods or services rendered and provided. Invoice financing is most appropriate for small to midsized businesses, with the inclusion of new companies who are just starting up as well as companies with few assets.

The Benefits Seen by Lenders

You may be wondering what a lender would gain from invoice financing. Why would lenders even be interested in fronting money in exchange for past due invoices and late paying customers? Like any borrowing scenario, there are benefits to invoice financing that lenders can reap. Invoice financing is similar to extending a line of credit in a traditional loan which, in all reality, is extending unsecured credit to a business. This places more faith on that business to pay it back without much collateral to secure it. 

With invoice financing, it’s a little bit of a different story, as the lender now limits their risk by not advancing the total amount of the invoice to the borrowing company. Some risk will remain in the borrowing game, even in accounts receivable financing. It’s reliant on the customer eventually paying the invoice, which they may never go through with that action.

If that were to occur, where does that leave the lender and the borrowing business? Well, they’re both now faced with an expensive and time-consuming collections process that involves both of these participating parties. The bank is reliant on repayment of these invoices for the loan and the borrowing company is reliant on the flow of money from the lender.

The details that drive invoice financing set up the loan transaction as a two-installment invoice sale. The first installment covers anywhere from 70-80% of the value of the business’ invoices, which is then deposited into their account for immediate use. Typically, this first transaction takes one or two business days to complete. 

As for the remaining percent the borrowing company receives this from their lender once their customer pays their outstanding invoice. Assuming that the lender received full payment on the outstanding invoices, they‘ll issue the second installment to the business, but the borrowing business will be responsible then in paying interests or fees for their services.

Alternatives to Invoice Factoring

There’s also invoice discounting, a similar method to invoice factoring, except that the business takes it upon themselves to collect payments from the customers instead of the lender. One advantage that invoice discounting presents is that customers won’t know that the business is undergoing invoice financing at all. Another benefit is that that lenders often advance the borrowing business up to 95% of the invoice amount in comparison to invoice factoring’s slightly less percentage of its first installment.

The most important aspect of invoice financing to pay attention to are the fees that come out of the factoring lines. On average, factoring lines range from 1.15%-4.5% per 30 days, but these factoring lines can be structured in numerous ways, all based on your business’ unique situation. The good thing about invoice financing, regardless as to whether your business opts for factoring or discounting, is that the line structuring is flexible. Lenders want you to be able to pay back what your business owes, but you’ll still need to be vigilant about scoping out the various fees and fine print that goes along with any sort of lending.

Asset-based loans are also an option for businesses struggling with optimal cash flow. Invoices are considered to be among viable assets, as well as equipment, inventory and machinery. These types of loans are best for companies that tend to invoice at least $750.000 per month as they’re more difficult to obtain, requiring more documentation than a factoring line.

Is Invoice Financing Right for Your Company?

Financial situations are as unique as fingerprints - no two are really alike. Your business could be an excellent contender for accounts receivable financing, but ultimately, it’ll be dependent on a number of factors. Businesses who are a good match for invoice financing must consider their current cash flow needs, their other options for short-term funding and the main focus of accounts receivable financing. If customer payments are a real concern, then invoice financing could be the right solution, but it’s worth for the business to consider all of their financing options.

There’s no way to really know how much invoice financing will cost your company, even with lenders listing out what they may refer to as “starting rates” on their website - it all could very well change. Be sure to get a quote in writing and go through the contract carefully, ensuring that you are signing up for what you intended.