Invoice financing: what is it and how does it work?
Get to Know Invoice Financing
Gerri Detweiler • May 11, 2022
Advantages and disadvantages of invoice financing
Invoice financing (or accounts receivable financing) has a lot to offer in the right situation, but there are also downsides to consider.
Benefits of Invoice Financing for Small Businesses
If you’re looking for a quick way to get a short-term type of financing, invoice financing can be a solid option. The application and approval process is much faster than with traditional loans, and funds can be deposited into your account in as little as one business day.
Disadvantages of Invoice Financing for Small Businesses
- Can be expensive
- Can be difficult to compare costs
- Generally not available to businesses with consumer customers (B2C)
The biggest downside to invoice financing solutions is the cost. While quick approvals can help you resolve cash flow issues almost immediately, you’ll pay for the convenience.
The fact that your warranty is your invoice may mean that certain types of businesses will not be immediately eligible. B2C (business-to-consumer) businesses looking for financial assistance may be out of luck, especially if their cash flow comes from a point-of-sale machine rather than long-term invoices.
Plus, the cost means you’re essentially missing out on all revenue from customer invoices, which impacts profit margins.
What is invoice financing?
Invoice financing, also known as accounts receivable financing, allows small businesses to quickly obtain financing for unpaid business-to-business invoices. In return for quick access to cash, a business pays the bill finance company a fee, often a percentage of the amount borrowed.
Types of invoice financing
- Factoring of invoices
An invoice factoring company purchases unpaid invoices at a discount and will be responsible for collecting payment on the invoices. You typically receive 50-85% of the invoice value upfront (also known as an invoice discount) depending on the risk profile of the customer who owes the invoice. Invoice factoring fees can be structured in a number of ways, but are typically around 3-5% of the invoice value.
- Invoice financing
A type of invoice financing allows the business to use accounts receivable as collateral for a short-term loan. The company will be responsible for repaying the loan, regardless of how quickly (or slowly) the customer pays. Fees are typically 2-4% per month.
- Receivables-based line of credit
A line of credit based on a percentage (usually 80-85%) of the value of your outstanding receivables. The value is calculated according to the age of the invoices. You will pay a pre-negotiated interest rate based on your balance. When an invoice is paid, your balance will be reduced. There’s usually a fee when you draw down the line of credit, but it’s usually a cheaper option than invoice factoring or invoice financing with effective APRs that are often less than 20%.
You may see very low advertised rates, but keep in mind that these are based on very short term financing. Use Nav’s free invoice financing calculator to convert the cost of invoice financing to an annual percentage rate (APR) so you can compare the cost to other financing options.
Factoring with recourse Vs. Non-Recourse Factoring
You may have noticed something interesting above: with invoice financing, it’s you who is ultimately responsible for collecting payment from your customers.
With invoice factoring, the invoice factoring company takes on those invoices and is responsible for collecting payment. If your customer never pays, the finance company can assume that risk. This is why invoice factoring tends to charge higher fees.
It is important to understand the difference between factoring or financing with recourse and without recourse. Recourse factoring means that the company is ultimately responsible if the invoice is not paid. With recourse factoring, the company that received the financing is ultimately responsible if the invoice is not paid. In other words, you may have to pay back the money you received from the factor.
Non-recourse financing means that the factoring or financing company is out of luck if the invoice is not paid. Note that invoice financing or factoring is not a substitute for debt collection.
Invoice financing options
Looking for an invoice financing or invoice factoring company? Here is an option to consider:
How to Apply and Qualify for Invoice Factoring or Financing
Compared to many small business financing options, the process of applying for invoice financing, invoice financing, or an invoice small business loan is a fairly quick and easy way to get money for your business. business. If the bill finance provider or finance company you have chosen has an online application, even better.
Due to the focus on the invoices themselves, almost any B2B company can qualify for invoice financing, provided the company responsible for the invoice has good credit risk. If the bills themselves make sense for the bill finance company to lend, they most likely will. In other words: if a given client has a habit of paying on time and has a good reputation, it’s probably a good risk for a finance company to take.
The amount financed or factored will depend on the quality of the invoices and the credit history, which in some cases refers to the credit of the borrower, and in other cases the credit of the company that owes the invoice.
There may be a personal credit check and the business credit may also be checked. The company can check the trade credit of the customer who owes the invoice, and authorization to do so is not required because anyone can check the trade credit.
You may be required to provide an aged accounts receivable report (A/R report) and/or company bank account statements as part of the application process.
Some companies may work with small businesses that have bad credit, while others may be better suited to younger startups or those with lower annual revenues, so it’s worth investigating the options.
Top Candidates for Invoice Financing
This type of financing is ideal for companies that invoice other companies (B2B invoices) for goods or services after they have been delivered. The company must regularly invoice other creditworthy companies. It is commonly used in industries with long billing cycles, such as apparel, retail, manufacturing, etc.
Fast-growing businesses can use this funding to continue to grow, and businesses with slow-paying customers (net-60, net-90 or more) may also find it helpful. Seasonal businesses can also use this form of financing.
This is generally not a good option for businesses with few invoices or seriously overdue customers. It is not intended to serve as debt collection.
Businesses with good credit who meet other business loan criteria may consider other lower-cost financing options, such as a business line of credit.
Industries best suited for invoice financing
This type of financing is very common in a number of industries, including:
- Construction and real estate
- Health services and medical providers
- Marketing services
- Recruitment companies
- oil and gas
- Business advice and legal services
Most types of businesses that regularly invoice other businesses, but need to get paid faster, can be candidates. However, invoice factoring or financing is generally not suitable for B2C businesses or subscription revenue companies.
When is invoice financing a good idea?
On-bill financing is often a good idea when a business needs to get financing faster and can’t qualify for less expensive financing. It may also be an option for small business owners who have a harder time qualifying for financing due to the industry they are in, time in business, credit ratings or other risk factors. qualification.
It can also be useful for businesses that cannot wait weeks or months for approval and funding for an SBA loan or a traditional small business loan.
Is invoice financing risky?
The invoice financing solution you use will determine the level of risk. Factoring invoices without recourse is the least risky for the borrower. Recourse factoring and invoice financing (loans) carry more risk. As with any type of debt, if your customer does not pay the bill, you may be required to repay the advance or loan you received.
What is the difference between invoice financing and invoice factoring?
Invoice financing is sometimes used as an umbrella term for financing secured by customer invoices as well as factoring. However, technically it is a loan (usually a short-term loan) secured by accounts receivable.
Nav’s Verdict: Invoice financing
The overall APR, typically 15-35%, is high compared to banks or online term lenders. But it is a good short-term solution, when most of your short-term assets are tied up in accounts receivable, it allows you to avoid the long bank loan application for a short-term loan, SBA loan, or other ways you could look to get some much needed money. It’s also much better than expensive merchant cash advances. Your credit score doesn’t matter as much either. Your customers’ credit ratings will also be taken into account. It is therefore a good solution if you have debts but you have not built up your credit history enough to obtain a line of credit from a bank.