Buying Invoices: How Does Invoice Trading Work
With low rates in the bond market and a stock market at an all-time high, investors sought alternative financing solutions. In this article, we're going to learn more about invoice trading, one of those alternative options that offer a new, high-return, secure, short-term asset class when buying invoices.
Invoice Trading Defined
Invoice trading is a method of borrowing money from investors through unpaid or overdue invoices. In effect, these invoices serve as a payment guarantee and are made possible by Invoice Trading platforms, which allow businesses to sell invoices to online investors.
The said invoice trading platforms, sometimes referred to as the invoice exchange platform, link companies experiencing cash flow issues with investors looking for short-term investments.
Simply put, invoice trading occurs when a business borrows money from an investor using its unpaid invoices as collateral. It’s also known to many as peer-to-peer financing, invoice finance, and invoice discounting.
Invoice Trading is Best For What Type of Company?
Invoice trading can be utilized by businesses of all sizes, especially if they're looking to improve their cash flow quickly without being tied to a contract, as is the case with conventional factoring contracts.
Businesses looking to boost their capital develop a partnership with invoicing markets. This alternative approach also allows them to generate cash, which they may utilize to improve their short-term liquidity, cover expenses, or even make new investments for their operations.
For most companies, invoice trading is particularly appealing because it frees up cash flow since managing working capital and keeping up with growing demand can be challenging, especially for SMEs.
How Does Invoice Trading Work?
Invoice trading requires the involvement of three entities:
- One or more investors interested in buying invoices
- Companies willing to sell their receivables
- An Invoice Trading Platform that will link the two parties
The traditional invoice trading process is straightforward since the platform acts as a trusted intermediary. The steps included in the process are as follows:
- The company that intends to assign invoices registers on the Invoice Trading platform and submits a profile to finalize its membership.
- As soon as the platform accepts the profile, the customer's account goes live. The company can then sell the invoices it wants to transfer.
- The system then verifies the invoices before posting them online and making them accessible to investors.
- Apart from the invoices and transaction details, investors will gain access to scoring and various information pertaining to the company.
- Afterward, one or more investors may either purchase shares of bills or entire bills. They may opt to diversify their invoice purchases to reduce potential risks.
- Once the deal is finalized, the selling company acquires the funds in its account. The advance can be up to 90% of the invoice amount and is payable within 24 to 72 hours or even within minutes.
- Once the debtor settles their invoice and the client has received it in their bank account, the invoice trading platform will release the remaining balance to the business after subtracting applicable fees and an additional amount, which is returned to the transferring company.
Bill owes a small office supplies firm that provides flexible payment arrangements to its customers. Bill receives a purchase order for $25,000.00. His office supply company delivers the supplies and gives the customer 90 days to settle the payment.
Although Bill made a $25,000 sale and delivered the products, he will only receive the full payment in three months. However, since Bill's company is a small local business, he needs the cash to purchase additional raw materials and covers other expenses as soon as possible.
In this scenario, invoice trading presents the ideal solution for Bill.
He can arrange an auction for the invoice he wants to trade by using an online marketplace that connects small and medium-sized businesses with trustworthy investors.
Once the auction is completed, Bill can receive a cash advance of around 80% of the invoice's value within a few days following the purchase. Then, the remaining funds, less applicable fees, will be available to him once the customer pays for the products after the 90-day period expires.
Benefits of Invoice Trading
The invoice marketplace will surely pique the interest of investors. For one, the process enables them to generate significant returns on investment by diversifying their financing. Unlike other forms of loans, invoice trading utilizes invoices as a guarantee, effectively minimizing the risks and providing investors with peace of mind.
Additionally, it enables businesses to access their money quickly, usually within a 48-hour timeframe. The funds are typically accessible right away since the entire process takes place online.
Compared to the different criteria and conditions associated with more traditional business loans and financial schemes, invoice trading is by far a more convenient option.
For Companies that Resell their Invoices
While immediate access to liquidity to satisfy cash flow needs is the primary benefit of invoice trading for businesses, there are numerous other advantages:
Firstly, invoice trading is an alternative financing solution that's quick and simple to set up entirely online. Secondly, it allows complete control and flexibility as companies only sell invoices when they find it necessary. They also get to pick the invoices, even the debtors involved.
Invoice Trading also ensures company confidentiality. Most debtors will not be told of the company's action, which has no bearing on their business relationship. Since
investors on invoice marketplaces are usually multinational, they can easily finance foreign invoices.
Lastly, companies aren't required to present assets as collateral.
Disadvantages of Invoice Trading
As a downside, invoice trading can be costly because of the charges associated with using the services, such as credit check fees, application fees, and processing fees. This can amount to 5% of the total amount of an invoice, which can end up being a considerable sum.
When dealing with debt, handing over the responsibility to an external service provider can be worrisome. Business owners may also be apprehensive that invoice trading services would contact their clients directly, which could harm the relationship they have with them.
Also, invoice trading is only feasible if the clients are other businesses and the invoices are commercial in nature. If they come from the general public, then invoice trading becomes a nonviable financing option.
Finally, invoice trading addresses issues of insufficient cash flow in a business, not other financial concerns. It won't be that beneficial if the clients are dependable, pay their bills on time, and have reasonable payment terms.
Other financing options may be more appropriate in specific cases. For instance, if you're searching for capital to cover the procurement of new equipment.
Invoice Trading FAQs
What are Invoice Trading Platforms Exactly?
Invoice trading platforms are websites that have been set up to facilitate the trade of either invoice or supply chain agreements. They link SMEs in need of working capital with investors looking for a profitable return. When conditions align, it creates a win-win scenario for both sides.
What are the Typical Costs of Invoice Trading?
The typical costs involved in invoice trading vary widely, depending on the amount of the invoice, the terms, and the industry concerned. Many companies guarantee borrowers "up to 90 percent of each invoice," but these terms are rarely achieved. In reality, a borrower receives approximately 75% of their invoice value at 2-3% interest rates, plus a processing fee charged per funded amount. These usually range from 0.5 to 1%, depending on the credit period.
What’s the Difference Between Invoice Factoring and Invoice Trading?
Invoice factoring usually entails having a third party manage your entire sales ledger. You will be tied into a facility that limits the amount of cash accessible to your company as it grows. Alternatively, if you seek to cut your funding and costs, you'll also be tied to a predetermined level of funding that you're paying for but may not really require. Due to concentration limits, you'll only get between 50% and 80% of the invoice in advance. The provider will also get involved in your client relationship by collecting and following up on payments directly from your customer.
Meanwhile, invoice trading is a dynamic new alternative to traditional discounting or factoring. It's beneficial if the company seeking working capital doesn't want to be bound by a fixed contract. Working with an innovative funding platform will work wonders as it will introduce you to a marketplace where companies sell their invoices to a large number of investors, lowering the cost of finance.
One primary upside is that sophisticated investors are better equipped to price risk in order to buy invoices and diversify their portfolios, eliminating any cap on concentration limits. Rather than committing your entire ledger, invoice trading allows you to choose which invoices to sell and when. Ultimately, you get to decide the amount of money you need to bring in for your business.
If you're looking for alternative financing options for your business, you'd want to learn more about invoice trading to determine whether it's right for you.
Currently, it's one of the smaller segments of alternative financing solutions. But, it's the fastest-growing method, particularly in Europe. The potential of this financing option is promising, especially given the volume of invoices due on the market.
One thing to remember is that invoice trading regulations differ significantly between countries. If you have a project, it's best that you get in touch with us to discuss how we can support the implementation and management of your cash flows!