Business Funding

What is Invoice Financing?

Read Time: 5 min

If you’ve been researching different funding options for your business, invoice financing might be a recurring suggestion. Business owners are constantly searching for creative ways to fund their companies. This is a unique type of financing that allows you to leverage the value of your business’s invoices. As with any type of funding, there are pros and cons associated with using invoice financing in your company. In this guide, we’re going to take a close look at invoice financing and other types of invoice funding. We’ll go over everything you need to know about invoice loans to make the right decision for your business.

What is Invoice Financing?

invoice financing

Invoice financing is when a business borrows money against the value of its invoices or accounts receivable. If a customer is yet to pay an outstanding invoice, this may create cash flow problems for your business. Some lenders allow you to borrow a percentage of the “Amount Due” in exchange for a fee or interest payment.

This is a useful tool for covering wages, stock purchases, and other business activities that require immediate working capital. This is a particularly popular option with businesses that have long payment cycles – and businesses that require upfront capital to complete large orders.

How Does Invoice Funding Work?

Invoice funding works by allowing lenders to secure a loan against the value of your outstanding invoices. Unlike lines of credit and business credit cards, this type of lending provides assurances to lenders that you will pay when the invoice is settled.

Keep in mind that many invoices have long payment terms. This means that it’s perfectly reasonable for there to be a significant gap between issuing and settling an invoice.

How Much Does Invoice Financing Cost?

Unfortunately, it’s impossible to determine the exact cost of invoice financing without more details about your company and lender. Your lender will want information on your business, its revenue, and its credit history. Additionally, they may need information about your customers, as the lender will be hoping your customers pay their invoices to cover the cost of the loan.

In some ways, invoice financing is low risk for lenders if your customer is reliable. Still, there’s always a chance that your accounts receivable goes unpaid, and your lender is left out of pocket.

If you’re searching for the cost of invoice financing, make sure to explore various options before you make any commitments. By comparing interest rates and lender fees from multiple lenders, you can rest assured that you’re receiving a fair market rate for your invoice funding.

How Invoice Loans are Structured

Invoice loans are typically awarded via a process called invoice discounting. A lender will provide you with a percentage of the invoice total, and you will repay that amount–with fees and interest–when the customer pays your invoice.

Alternatively, there is another type of invoice financing option called invoice factoring. This will be covered more extensively later in this guide.

The Pros and Cons of Invoice Finance

As a business owner, it’s critical to assess the advantages and disadvantages of any form of funding. Whether it’s borrowing, investment, or any other type of business funding mechanism, there will always be benefits and drawbacks. Below, let’s explore the pros and cons of using invoice finance in your business:

Pros

Invoice financing:

  • Allows you to benefit from your accounts receivable
  • Lets you receive payment before your invoice’s due date
  • Is typically accessible at short notice
  • Can help you plug temporary gaps in cash flow

Cons

  • Invoice financing can be an expensive form of financing, depending on your lender
  • You’re still reliant on your customer to pay their invoice so you can repay your loan
  • It’s only a temporary solution to cash flow issues
  • Some invoice financing companies will inform your customer, which can be bad for your business’s reputation.

Invoice Financing vs. Factoring

invoice financing definition

If you’re researching invoice financing, there’s a good chance you’ve also heard of invoice factoring. Many individuals confuse these two types of funding. While they’re both funding options that allow you to use your invoices to your advantage, their underlying mechanisms are slightly different. Still, it’s important to recognize that some companies use these terms interchangeably.

If you’re considering invoice financing, you’re likely referring to invoice discounting. This type of financing involves your lender providing you a discounted amount of the invoice in cash. For example, your lender may let you borrow 90% of the value of the invoices.

On the other hand, invoice factoring involves selling the invoice to a lender. The lender will then be responsible for collecting the money from the invoice. You will have pre-defined terms involved in this exchange – you will receive a certain percentage of the invoice, and the lender will extract fees and other charges.

One of the primary disadvantages of using invoice factoring (instead of invoice discounting) is that factoring requires the consent of your customer. As your lender will be collecting money directly from your customer, your customer will be aware that you are factoring invoices. As this can be a sign of cash flow problems, it can cause reputational damage to your business.

How to Apply for Invoice Financing

If you believe that invoice financing is correct for your business, it’s time to begin the application process. While the application process can change depending on your lender and other variables, the general approach will remain the same across the board.

Start by searching for an invoice financing company that offers loans online or in your area. The lender will require information about your business, its customers, and invoices. Once you supply core details and verify any information requests, it won’t be long until the invoice financing company offers you a response.

Now that you understand the ins and outs of invoice financing, it’s time to decide if this funding option is suitable for your business. As with any business decision, it’s best to assess the alternative options before you choose. In many cases, business owners will use a variety of funding sources to meet the cash demands of their operations.