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What is Invoice Financing
Let’s say you run a hardware business and your customers order materials in bulk. They sign a contract allowing the buyers to pay their balance, say $10,000, within 30 or 90 days.
But the problem is that you need to pay for certain business expenses in 15 days. Since you’re $10,000 short on cash, you’ll find it harder to fulfill your payment obligations. In this situation, you can sell your outstanding accounts receivable to invoice funding companies.
The main benefit of invoice factoring is that it frees up cash tied to your outstanding invoices. With more cash available, you can cover its day-to-day expenses. At the same time, you can take in more customers and invest in opportunities. Growth and expansion become easily attainable for the company.
Types of Invoice Factoring
Invoice factoring is the most common type of invoice factoring small businesses apply for. In this arrangement, the merchants (borrowing party) sell their outstanding invoices to factoring companies. The financing company then takes full control of the company’s invoices the does the payment collection. Once the customers pay the invoices, the financing company then deducts the cash advance plus the fees. Then, the remaining balance is sent back to the business.
One of the main advantages of invoice factoring is that you won’t have to deal with payment chasing. This is especially true in companies that don’t have enough resources to do the payment collection themselves.
Invoice Factoring also comes in two types: recourse and non-recourse factoring.
Recourse Factoring is the most commonly used form of factoring. In this case, if your customers default on their invoices, you’ll be the one responsible for the payments. It is a common misconception that a business is not responsible for the invoice once it is sold, but if the invoice is not paid, the business must cover the money their customers owed.
In non-recourse factoring, the lending company assumes the full risk of the invoices. This means that if the invoices remain unpaid, the factoring company has to take the loss and shoulder the costs. Non-recourse factoring is best for companies that have strong financials and reliable customers.
In spot factoring, businesses sell only a single invoice to the financing company. It’s usually a one-time transaction and the lenders usually don’t expect to do repeat business with the borrowers in the future. Companies will typically use spot factoring for big orders that tie up necessary operating cash flow. It’s the perfect option for businesses that find themselves in need of an immediate financing solution.
Selective Invoice Financing
What are the Benefits of Invoice Financing?
Other than that, here are other reasons why invoice financing is a great option for your business:
Immediate Cash Flow
Approval is quick and easy. Since the lenders don’t focus much on the borrower’s credit score, even businesses with poor credit can qualify.
No Additional Collateral Needed
Technically speaking, invoice financing is not a loan. Since the invoices are sold to lenders, you do not owe anything to the financing company. Since there’s no loan to guarantee, there’s no need to present additional collateral.
Business’ Borrowing Capacity Grows with Business
Accept Bigger Projects
Manage Late Paying Customers
Avoid Missed Payment Deadlines
Collateral Used in Invoice Financing
What Are Accounts Receivable (A/R)?
Accounts receivable (A/R), also called invoice, is the amount that a customer owes to a business after a sale or service has been rendered. The company then collects the balance within a specific period – usually 30 to 90 days – depending on the agreement between the business and its clients. The amount owed is then recorded in the company’s general Accounts Receivable ledger.
In invoice finance, the only asset that businesses can use to secure the funding is their accounts receivables. It’s a great option if the business is looking for immediate cash. They can have access to additional working capital immediately instead of waiting for their clients to pay their invoices.
Why Businesses use Invoice Financing
By accelerating payments on invoices, there is an immediate influx of working capital. With more cash, you can cover their day-to-day expenses, purchase new inventory and materials, bridge the cash flow gaps, resolve tight cash flow from seasonality, and grow.
1. Day-to-day Operating Expenses
Smart business owners create financing plans to make sure funds are coming in from multiple routes. Invoice finance is one option for business owners to increase working capital by taking advantage of their accounts receivables.
2. Purchase Inventory and Materials
3. Bridge Cash Flow Gaps
4. Resolve Tight Cash for Seasonal Businesses
5. Business Growth
What Industries Benefit Most from Invoice Financing?
Businesses that do not use invoices to receive payment will need to consider other financing options. The most common and best industries that best benefits from invoice lending are transportation and logistics, wholesale and distribution, temporary staffing, and manufacturing.
Transportation and Logistics
Invoice factoring offers flexibility to a transportation and logistics company as it provides an additional avenue for funding. By selling their invoices, they can have the cash immediately which eliminates the need for them to wait for their clients’ payments.
Wholesale and Distribution
Invoice factoring is a solution for many temporary staffing business owners. It allows them to receive funds based on the value of their client’s accounts receivable. Instead of waiting for their clients to pay them for those ongoing hours, temporary staffing agencies that utilize invoice lending can maintain enough working capital and stabilize their cash flow.
As a manufacturing business owner, it is important to keep up working capital to maintain the appropriate amount of materials and inventory. This way, you can supply the clients’ needs and avoid losing projects. Invoice factoring provides a way for these types of business owners to take advantage of their accounts receivable to maintain steady cash flow.
Invoice Financing Rates
Lending companies often agree to fund up to 95% of the business’ total invoice amount. Of course, the eligibility of a business would depend on the creditworthiness of its customers. So, before applying, a company has to make sure that their customers have a good credit rating.
Aside from that, fees are also charged at every transaction. But, the rates are very reasonable. The rates for invoice financing usually depends on a lot of factors, including
Type of industry the business is in
The value of the accounts receivables
The number of invoices sold
Repayment period of the invoices
The creditworthiness of the client’s customers
Ineligible Invoices for Invoice Financing
Progress Billing happens when a big project cannot be completed unless a portion of the project has been paid. Construction companies usually do this type of invoice. However, financing companies may not accept these invoices as they typically require accounts receivables to be contingent-free.
Pre-Billing happens when a company bills its customers before the completion of a project. Unless the services are rendered or the goods are shipped to the customer, this type of invoice is not eligible for invoice financing.
Milestone Billing is a form of billing where the total amount of the invoice is billed over a set period and at multiple points along the process. When each milestone of the project is completed, the lender will issue a bill for each milestone that has been reached.
Step-By-Step Guide in Invoice Financing
Step 1. Invoicing
Step 2. The Business Sells its Invoice to the Invoice Financing Company
Step 3. The Financing Company Evaluates the Application
Step 4. Approval
Step 5. Customers Pay Their Invoices
Step 6. Payment
What Documents are Needed
A/R Aging Report
P&L and Balance Sheet
Articles of Organization or Incorporation
Sample Customer Invoice
Completed Invoice Financing Application Sheet
Proof of Identity
Is invoice financing a good idea?
Perhaps you have pending bills and debts to pay that are beyond what you anticipated, or your cost of sales have spiked due to temporary manpower or equipment needs. Rather than take on new debts, invoice financing allows you to sell your existing invoices (money you’re owed) for immediate access to funds.
How does invoice financing work for the business?
Invoice financing helps you meet your liquidity requirements so you have the cash to pay for timely financial obligations like employee salary, utilities, rent, and credit card bills, among others. You’ll avoid late payment charges and build the trust of your suppliers and partners as you’re settling your payment commitments on time.
A similar alternative to invoice financing is invoice factoring, which also gives you immediate access to the funds you need.
What is the difference between invoice financing and factoring?
With both methods, you typically receive around 80% of your invoice upfront, minus a lender’s fee, and then the remaining amount once your customer has paid.
Is invoice financing a loan?
Invoice financing is essentially a cash advance you get from a lender in exchange for your invoice’s worth (money you’re already owed). Financiers pay for your customers’ payments ahead of time, at a discounted rate, minus the fees. Once the customer pays, your debts are settled. There are no reoccurring repayments owed.
Why Work With SMB Compass?
Before moving forward, we make sure that our clients’ questions are answered and they understand the details of each of the financing options available to them. With a dedicated lending specialist and multiple points of contact, our clients are assured of only the best responses and top-notch customer service.