A Beginner’s Guide to Invoice Financing Definition for Business Growth

Ezra Cabrera | August 19, 2022


    Invoice financing is a type of short-term borrowing extended to your business by a lending institution based on your customer's unpaid invoices. 

    It means you can get your invoices paid immediately rather than waiting for a longer time. Collecting payments from your customers can take a lot of time. With this method, you'll be able to save time. Your company can make the most of its earnings by improving cash flow, stabilizing revenue, and lowering the risk of bad debt.

    You can use the money from financing invoices to develop new products, launch initiatives, buy new equipment, remodel your business' structure, open another branch, among other things. Invoice financing is beneficial and your more sensible funding option if you seek timely funding to invest in your business. It can cover your operating expenses while still waiting for the unpaid invoices from your customers.

    Please keep reading to know how invoice financing is structured, its benefits and drawbacks and whether it is suitable for your business or not.

    How Invoice Financing is Structured

    One characteristic of invoice financing that is crucial to understand is that if your company refuses to complete a settlement to the lender, your customers' invoices will serve as collateral against the debt. You may accomplish invoice financing in two ways: one is via factoring, and the other is by discounting invoices. It is possible to use invoice financing as your business financing option since it allows you to receive cash quickly rather than waiting for your clients to pay you in full. 

    Customers who take a lot of time to pay their invoices may cause credit and cash flow difficulties, which you can avoid if the working capital is kept well stocked. As a result, it is a viable option for your slow-moving accounts receivable, meeting your business's short-term corporate liquidity requirements. When it comes to structuring invoice financing, you may use two main approaches. These are factoring and discounting. Factoring, as defined, is a method of selling unpaid invoices to a banker or bank. The lender should pay your company up to 75% of the invoice value beforehand. The lender will refund the balance minus any interest or additional fees if clients pay in whole. 

    Furthermore, if the lender obtains full payment for the bills, it will complete the remaining 15% to 30% of such cost amounts to your firm, with the latter making payments or transaction fees for the service. You must inform customers of this arrangement since the lender receives payments, adversely affecting the firm. While discounting allows your company to collect up to 90% of the invoices' value. Contrary to factoring, your firm receives money from consumers and gives it back to the lender when a client pays the company, the lender, or bank back less the charge or interest. 

    Benefits and Drawbacks

    More and more companies are searching for short-term assistance to help them get through the prolonged payment cycles. This section will discuss the benefits and drawbacks of invoice financing for businesses further below.

    It is important to have capital on hand so your business can make progress towards its desired goals. Invoice financing is one of the options that could help the company to have a better cash flow. One of the benefits of having invoice financing is allowing the businesses to receive early payment of invoices to reduce days of sales outstanding. Invoice financing will help your business grow more because it offers more predictable cash flows. 

    Having predictable cash flows will help you decide on your plans and possible outcomes. It also provides necessary cash; it entitles you to repayment only from the business' profits. Invoice financing is solvent financing that won't show up on your books. If you find a suitable financing firm to work with, the fees you need to pay may be as low as possible. Getting invoice financing doesn't require you to have good credit. Frequently, invoice financing firms use the credit scores of your customer rather than your credit scores for a high chance of getting qualified.

    There are downsides to any source of funding. Invoice financing isn't best for every company, and there are a few drawbacks to be aware of before making a choice. It may be possible that it will be more expensive than traditional finance. Some invoice finance firms charge excessive fees. Be aware of the charge structure to get the most of the money you owe. They will help you with your cash flow drawbacks. If the company has additional difficulties, they will persist. The difference is that you may have more cash on hand to address them. Make direct touch with your consumers, informing them that you have funds for your invoices. 

    Should You Apply for Invoice Financing?

    This depends on your business' goals and financial capacity. The financial structures of companies are unique based on their operations, and various financing options make more sense than others based on a particular situation. Moreover, invoice financing tends to be the cheapest that your business can easily afford than any other. It gives your business's reputation control since you can give your customers more time to pay instead of forcing them immediately. 

    Despite that, please remember other considerations before deciding if it's right for your business. Firstly, do not be overconfident that it combats your cash flow issues. It would be best if you minded that it is not a replacement for your revenue. Nonetheless, it can give you cash injections when your operation is slow, winning sales and raising successful invoices.

    Another thing is that you must accept payment sooner depending on what invoice financing solution you use than you would with factoring. The application in factoring is time-consuming as you tend to receive funds in longer days. On the other hand, you can only get the payment within two or three days with invoice financing.

    Final Thoughts

    Invoice financing is when your company sells an invoice to a third party. It helps your business have a smooth and faster cash flow that allows you to pay your employees and suppliers. Additionally, you can reinvest in your business activities and development instead of waiting for the customers to settle their obligations.

    Several benefits of using invoice financing include receiving early payment of invoices and reducing receivables. Moreover, accurate forecasting of cash flows will assist you in making business plans and decisions for better operations. However, this method is not compatible with every business type, and there are a few things to consider, like the fees of third-party companies.

    Invoice financing is the ideal option to cover your expenses in a shorter period. However, it would be best to remember that it is not a replacement for your revenue while combating your cash flow issues. It only gives you injections to raise your invoices and win sales when your business operates slowly.

    Overall, invoice financing can provide you with immediate funds to develop business products and services as an approach to improve your cash flow. Furthermore, purchasing additional materials and new equipment for operations is feasible. Invoice financing can be an excellent remedy if your business needs immediate funding. Operating expenses can be covered, and waiting time for clients will be saved.

    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.