4 Types of Invoice Financing for Small Businesses

Ezra Cabrera | August 19, 2022


    Curious about different types of invoice financing? If you have slow-paying customers, you’re more prone to cash flow issues than other businesses. It’s worth noting that approximately 82% of startups fail because of cash flow mismanagement, according to a study by the U.S. Bank. That said, it’s crucial to have a backup plan in case you find yourself in a cash pinch.

    All types of Invoice financing can be a helpful financial resource if you face cash flow problems because of unpaid invoices. Unlike other types of business financing, the application for invoice financing is faster and more flexible.

    There are many forms of invoice financing, and we’ll discuss each of them below.

    How Does Invoice Financing Work?

    Before we get into the different types of invoice financing, we’ll quickly go over how the financing works first.

    Invoice financing is a type of business financing where companies borrow capital against their customer’s unpaid invoices. The lender will advance anywhere between 80% to 90% of the total value of the invoices and hold the remaining 10% to 20% until the customers pay their dues.

    Invoices usually have a net term of 30 to 90 days. Instead of waiting for the customers to settle their balances, companies opt to finance their invoices to accelerate capital and cover their financial obligations. Once the invoices are paid, the invoice financing provider deducts the advanced amount, plus a small fee. The lender then will wire the remaining funds back to the business.

    What are the Different Types of Invoice Financing?

    There are four types of invoice financing: invoice factoring, invoice discounting, spot factoring, and selective invoice financing. Here’s how each option works.

    Invoice Factoring

    Invoice factoring allows businesses to ‘sell’ their invoices to an invoice factoring company or a factor. With this type of financing, the lenders will demand full control over your accounts receivable ledger. That means they will also be in charge of the payment collection.

    It’s worth noting that when the factor handles the payment collection, your clients may become aware that you’re using an invoice factoring company. While others may be fine with the arrangement, this may not sit well with other companies, especially if they prioritize client relationships.

    Invoice factoring can be further classified as recourse and non-recourse factoring. The difference between the two lies in who is responsible for the invoices in the event that the customers fail to settle their accounts.

    • Recourse Factoring. With recourse factoring, the borrowing business takes 100% of the responsibility. If one of their customers fails to make payments, they will have to make up for the lender’s losses. They can either replace the invoice with another that holds the same value or pay the invoice themselves.
    • Non-recourse Factoring. In non-recourse factoring, the lenders will take full responsibility for the invoices. Once the company transfers the ledger to the factors, they won’t be liable for the invoices anymore. In other words, if one or a few customers don’t settle their balances, the invoice factoring company will shoulder all the losses.

    Recourse factoring is more commonly offered because it’s less risky for the lenders. It’s also a cheaper option than non-recourse factoring.

    Invoice Discounting

    If you prefer handling the payment collection yourself, invoice discounting might be a better choice for your company. With invoice discounting, you will retain full control over your accounts receivable ledger. That means that your customers will pay through you, and when all the invoices are settled, you’ll pay the invoice financing company the amount you owe, plus the factoring rate and other fees.

    Invoice discounting is an excellent choice if you have the resources to pour into payment collection. This allows you to maintain customer relationships, and it keeps your relationship with the factoring company confidential. Specifically, invoice discounting is a better option for larger companies with a solid customer base.Spot Factoring

    In invoice factoring and discounting, the lenders may require you to pledge all your unpaid customer invoices. With spot factoring, you can choose a single invoice you want to finance or sell. Invoices pledged are usually high value, and factors may impose a minimum invoice value before they agree on the financing.

    Spot factoring is usually a one-time service. Once the repayment terms are up, the lenders typically don’t expect the business to come back for another invoice financing arrangement. Spot factoring is the best choice if you’re looking for fast access to capital because of a temporary cash-flow gap.

    Like invoice factoring, businesses may have to give up control over the invoices they choose to finance. The factors will then be responsible for payment collection. Once the invoices are settled, the factor will deduct the advanced amount, plus the transaction fees, and wire the remainder back to the business.

    Selective Invoice Financing

    Selective invoice financing is a hybrid of spot factoring and traditional invoice factoring. Like spot factoring, the business has the freedom to choose which invoices they want to sell to the factoring company. However, in this arrangement, they can opt to factor multiple invoices at once, which is especially helpful if they need an additional cash injection.

    Selective invoice factoring is more suitable for companies that have a mixture of small and large clients or those with irregular sales.

    Qualifying and Applying for Invoice Financing

    If you’re a B2B business, you’ll most likely qualify for invoice financing. However, you have to ensure that you’re working with reputable clients. Lenders are risk-averse, and they want to make sure that if they decide to lend against your invoices, they will get the money back in full.

    While your credit score may not matter much to the invoice financing company, they may still do a background check on your business’ credit standing. If you have a history of missed payments or unpaid debts, this may affect the terms of the financing.

    Unlike the typical small business loan, the application process for invoice financing is usually faster and more straightforward. Some invoice financing companies may offer online applications, which can make applications easier. Once approved, the funds will be in your account in as fast as 24 hours.

    The Bottom Line

    Different types of invoice financing offers different benefits for businesses. It offers a quick and easy way to generate capital when cash flow is tight. It also comes in different forms, so you can choose which one best suits your business's current needs. Whether you need to finance a single invoice or your entire ledger, you can find the right invoice financing type for you.

    Like other financing options, be sure to understand what the financing entails before fully committing to it. As much as possible, go through the invoice financing agreement and review the terms to avoid surprises in the future.


    See Alson: Invoice Financing Calculator

    About the Author

    Ezra Neiel Cabrera has a bachelor’s degree in Business Administration with a major in Entrepreneurial Marketing. Over the last 3 years, she has been writing business-centric articles to help small business owners grow and expand. Ezra mainly writes for SMB Compass, but you can find some of her work in All Business, Small Biz Daily, LaunchHouse, Marketing2Business, and Clutch, among others. When she’s not writing, you’ll find her in bed eating cookies and binge-watching Netflix.

    Leave a Comment