Businesses can finance their invoices through invoice financing.
This may sound peculiar, but there is a reason for the existence of this financing option.
Invoice financing is a solution offered by finance companies to mid-sized businesses (those with a stable supply of invoices and a proven track record).
The financing company buys your invoices from you at a discount and sells them at the total price to their customers.
You can choose to take the cash in whole or get a part of the discounted price in cash and the rest in a line of credit.
It is a relatively simple process that only requires a few steps to be completed.
Invoice Financing: How Does it Work?
Invoice financing is a form of debt secured by an asset that allows borrowers to receive an advance of money for outstanding invoices.
These are geared towards business owners wanting to pay back their capital with interest over time rather than as a lump sum.
Many companies, which offer invoice financing, offer you 85% of the invoices’ value, keeping the rest until you receive the payments.
Upon your customer’s payment, you’ll receive 15% of the invoice’s amount minus any fees the lender puts on top.
Fees for each week a customer takes to pay usually range from 1% to 2%. This factor fee is added to the total amount of the invoice, usually weekly.
Paying for invoice financing means you get fast and immediate access to capital, enabling you to free up cash flow that has been stalled for unpaid invoices.
What Are The Costs Of Invoice Financing?
The annual percentage rate (APR) for invoice financing can be 10% – 60%. Here is an example to illustrate how expensive invoice financing can be:
Imagine that you have a $100,000 invoice with a date of payment of 30 days.
You will receive 85% (eighty-five thousand dollars) of the cash advance amount and treat the remaining fifteen thousand dollars as a reserve.
Moreover, a 3% processing fee will be charged in addition to a 1% factor rate every week the invoice isn’t paid.
In this example, it takes customers two weeks to settle their invoices, so you’ll be charged a 2% factoring fee ($2,000) plus a 3% processing fee ($3,000).
As a result, the $15,000 held in reserve by the financing firm is only worth $10,000 ($15,000 – $5,000 in fees). This gives you a total APR of roughly 70% for invoice financing.
What Types Of Invoice Financing Are Available?
Factoring and lines of credit for receivables or accounts receivable are two of the main types of invoice financing.
Different types of funding are used interchangeably, but there are differences between factoring and invoice financing.
Invoice factoring is different from invoice financing in that you sell your invoices to a factoring company at a discount instead of paying back the cash advances.
Typically, invoice factoring companies secure payments from your customers.
Credit Lines For Accounts Receivables
A line of credit for accounts receivables is a financing method that uses your unpaid invoices to finance a credit line. In this case, the credit line is secured by your invoices. The amount of the credit is typically up to 85% of the invoices’ value.
The accounts receivable line of credit operates differently than traditional invoice financing and invoice factoring, which gives you an advance of the value of your invoices.
When you receive payment from a client, that amount is deducted from your accounts receivable line of credit.
You may also be charged a draw fee by some lenders each time you tap into a credit line.
Most accounts receivable lines of credit (as opposed to factoring) are like traditional invoice financing.
Your invoices belong to you; you collect payment from customers.
Often to streamline this process, you can use special invoicing software such as Payt Software to keep things under control.
This is extremely important if you are handling many invoices at the same time and need to keep track of who owes you what.
Advantages and Disadvantages of Invoice Financing
Indeed, invoice financing won’t suit every business, just like any other kind of funding.
As a general rule, it’s ideal for business-to-business (B2B) financing.
Working Capital Can Be Raised Quickly
Your receivables collateralize invoice financing, so it is often delivered quickly, primarily when your lender uses a fully online-based application process.
Your application could be processed within one day.
Reduces Cash Flow Issues Due To Unpaid Invoices
Invoice financing offers you the ability to get over upcoming cash flow shortfalls, such as taxes or payroll, by giving you the cash flow you need to pay those expenses.
Easy To Qualify For Compared To Other Forms Of Business Financing
The requirements you need to meet to receive invoice financing will vary depending on the lender.
Still, in general, you’ll find that the lender will be much more flexible when it comes to qualifications since invoices back invoice financing.
Besides your credit score and financials, the payments made by your customers are also of importance to lenders.
The Collateral Is The Invoice Itself
This financing works by using invoices as collateral, making it not only much easier to qualify for, but it increases your chances of not being required to put up any collateral other than your invoices.
Payments On Time Means Low Cost
Even though invoice financing is more expensive than other financing products, it is still relatively affordable, especially if your customers pay on time.
Unlike a traditional loan where you pay interest throughout the term, invoice financing only charges fees while the invoice is still outstanding.
Fees For These Types Of Financing Can Be Higher Compared To Other Types
You can often find that invoice financing fees can be costly compared to other types of loans, so it’s not as affordable as some people think.
The lender may also require that you pay extraneous fees or meet minimum monthly payments, depending on the terms of your loan.
An Upfront Cost Assessment Is Difficult
Invoice financing calculators are helpful for estimating costs to an extent, but it is difficult to determine exact costs ahead of time.
Because the ultimate payment will be determined by the length of time your customer takes to pay, this financing cost will vary.
Non Paying Customers Can Be Costly And Risky
As a result, if your customers fail to pay their invoices on time, this form of financing will end up costing you a lot.
In some cases, customers are charged late fees or increase their interest rates if they fail to pay their debts on time.
Conversely, if your customer doesn’t pay, you’ll typically be required to repay the lender in full—which could lead to a negative impact on your cash flow.
Not Available to B2C Business
Last but not least, we discussed that invoice financing is a particular option—you need to be in the process of collecting outstanding invoices to qualify.
As a result, if you’re a business-to-consumer or subscription-based business, you’re unlikely to get financing this way.
When it comes down to it, invoice financing is the ideal solution for businesses that rely on B2B or service-based revenues to generate cash flow.
Many alternative lenders offer online-based, streamlined application processes for invoice financing compared to many other financing products.
Although invoice financing can be advantageous, it can also be costly, especially when your customers either pay late or end up not paying at all.
To make sure you find the most affordable, the best solution for your business, you’ll want to evaluate all your options before opting for this type of finance.
Disclosure: As an Amazon Associate, I earn from qualifying purchases. The commission help keep the rest of my content free, so thank you!