What Is Invoice Financing? (With Types and Pros and Cons)

By Indeed Editorial Team

Published 26 April 2022

The Indeed Editorial Team comprises a diverse and talented team of writers, researchers and subject matter experts equipped with Indeed's data and insights to deliver useful tips to help guide your career journey.

Businesses finance their invoices to acquire capital immediately to complete deals and maintain their operations. They can use it to make quick payments to their suppliers and make their credit more flexible. Understanding more about financing orders, their various types and their pros and cons can help you pursue a career in finance or accounting. In this article, we discuss what invoice financing is and how it works, explore its types and requirements, and answer some frequently asked questions about it.

What's invoice financing?

Invoice financing is a type of financing that allows businesses to borrow money from lenders while they wait for customers to pay their invoices. It's also known as invoice discounting or receivables financing. Businesses can use receivables financing to manage their cash flow, promote business growth and keep production operating. It can also help them continue their operations without being affected by cash flow issues because customers are taking a long time to pay their balances. It's used primarily by companies that have a business-to-business (B2B) model.
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How does invoice financing work?

It's common for many businesses to sell their products and services on a credit basis to their customers, which usually doesn't involve any upfront payment. Once businesses sell their products or services to their customers, they create invoices that are typically payable within 30 to 90 days. They can then use these invoices to get financing from a lender to receive funding to continue daily operations, pay their suppliers or invest in expansion plans. Here are the steps involved in getting invoices financed:

  1. A business sells its products or services to its customers and invoices them.

  2. The business provides the details of those invoices to a financing service.

  3. The financing service pays a percentage of the face value of those invoices to the business.

  4. Once the invoice payment time comes, the business receives payments from its customers.

  5. The business then reimburses the financing service with the invoice payment and also pays any fees and interest charged by the financing service to settle the account.

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Which industries typically use invoice finance?

Businesses with long billing cycles typically use this financing solution to control their cash flow and maintain their regular operations. Here are common industries that typically use invoice finance:

  • Retail

  • Manufacturing

  • Construction

  • Wholesale and distribution

  • Logistics

  • Agriculture

What are the various types of receivable financing?

Here are the various types of receivables financing a business can utilise:

Invoice factoring

In invoice factoring, a business sells its invoices to a financing service in exchange for receiving immediate access to funds. This type of receivables financing transfers possession of an invoice to the lender, so they have the responsibility for collecting payments on the invoice. While it removes the duty of collecting payment from a business, it can affect its customer relations, since selling its invoices results in the lender interacting with the customer. It's important for businesses to select an invoice factoring service that values customer relations and can help maintain positive relationships with customers.

Spot factoring

Spot factoring is a type of receivables financing in which businesses can sell single invoices instead of selling their entire collection to a lender. Businesses use this method as a one-time solution to alleviate their cash flow issues immediately. Spot factoring usually comes with higher fees and interest rates, as it's a one-time solution. Some spot factoring services also offer to handle payment collection if the invoices are significant.

Selective invoice discounting

Also known as selective factoring, selective invoice discounting comprises conventional factoring and spot factoring. While spot factoring allows businesses to finance only a single invoice at a time, selective invoice discounting permits them to finance one or more instead of selling their entire invoice collection. It offers businesses additional convenience and control, as they can acquire immediate capital and select which invoices they want to finance. It's also usually a cheaper approach than spot factoring, with lower fees and interest rates.

Online invoice auctioning

Online invoice auctioning is a way for businesses to sell their invoices on online platforms instead of using financing services. Businesses can select which invoices they wish to finance, upload them to the platform where lenders bid to provide the best terms. This gives businesses more control, as they can choose the highest bids with more flexibility and also allows them to choose different lenders for their invoices.

This method may also lead to lower fees and interest rates, as lenders are competing to secure bids. While it's a convenient option, it may take time to receive bids, which can delay funding.

Pros of receivables financing

Here are the pros of using receivables financing:

  • Alleviates cash flow: The primary reason businesses use invoice finance is to improve their cash flow and fulfil their present needs. It allows the immediate release of funds so a business can continue paying for its expenses.

  • Extend payment terms: A business that uses invoice finance can offer more flexible and extended payment terms to their customers. This helps maintain business growth, steady cash flows and customer base expansion.

  • Easier to qualify for: While other financing sources may require extensive credit records to receive funds, it's usually easier to qualify for invoice finance. If a business has a steady customer base and no major financial issues, it can qualify for most invoice finance services.

  • Scalable: If a business is performing well with steady growth in invoices and revenue, it can qualify for more funding through its financing credit lines.

  • Protects fixed assets: Businesses can use just their invoices as security. This is beneficial for companies with minimal fixed assets they can use for collateral.

Potential cons of receivables financing

Here are the potential cons of using receivables financing:

  • Provides a specific solution: It doesn't provide much benefit to businesses with short payment terms and has customers that pay balances on time.

  • Profit rates may drop: receivables financing services usually charge fees and interest on the borrowed amount when businesses pay them back. This results in extra expenses that can affect a company's revenue and decrease its profit margin.

  • Expensive source for immediate funds: If a business requires immediate access to funds and uses receivables financing, it may end up costing more than other funding sources. As invoices are usually short term, receivables financing solutions are also often short-term loans that have higher interest rates.

  • Customers may default on invoices: A customer may default on an invoice payment, which can result in a company not having enough cash to repay lenders. This can lead to lenders applying default interest rates and fees that are much higher than the original rates.

Frequently asked questions about receivables financing

Here are the answers to some frequently asked questions about receivables financing:

Is invoice financing risky?

Receivables financing can be risky, as businesses can become too dependent on using this financing method. While it's a solution for acquiring fast capital and maintaining production while waiting for customers to pay, they may end up paying substantial fees to the financing service if their customers take too long to pay. It's important for businesses to select financing services carefully and choose ones that are cost-friendly and offer more payment flexibility.

What's the difference between invoice factoring and financing?

While they're both methods to gain credit flexibility for businesses, receivables financing involves using invoices as proof to pay back lenders whereas, in invoice factoring the lender buys the invoices from the business. Businesses using factoring neither own nor collect the invoices from their customers after selling them to the lender. While in receivables financing, the business owns the invoices and is responsible for invoice processing and customer relations. Invoice factoring is also usually more expensive than invoice discounting, as lenders often charge more for the risk factor of a customer not paying.
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What are the requirements for businesses to qualify for receivables financing services?

Any B2B business can qualify for receivables financing funds by proving its good reputation and steady customer payment history. The financing amount provided by a lender is usually based on the quantity and quality of invoices. Some receivables financing services may ask to see the credit history of a business to approve a financing agreement. If a business can provide good quality invoices with a customer base that has a track record of paying on time, it can qualify for financing services.

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