Invoice Financing Explained

Published by
Lethabo Ntsoane

Invoice Financing is a form of financing that provides leverage for businesses when their invoices are not yet due. This type of finance offer is popular with fintech start-ups such as Lulalend and Bridgement Finance. Traditional banks also offer invoice financing services to small and large businesses. 

What is Invoice Financing?

Invoice Financing is a type of short-term borrowing that allows businesses to borrow money against amounts owed to them by customers. The loan is secured by future expected cash inflows from customers, with funds expected to be deposited in favor of the borrower within 30 to 90 days. 

Invoice Financing works as financial leverage for borrowers so that they can meet their immediate obligations such as paying employees, paying suppliers, reinvesting in operations, and more. The borrower will pay a percentage of the invoice amount to the lender as a fee for borrowing money. 

Characteristics of  Invoice Financing

  • Companies or firms use this type of funding to meet their short-term liquidity needs by cashing in their accounts receivable before they become due.
  • Invoice Financing allows a business to use its unpaid invoices as collateral for immediate financing.
  • The borrower pays a percentage of the invoice amount to the lender as a fee for borrowing the money.
  • The solution helps companies with debtors that take too long to pay their debt.
  • Borrowers have the option of choosing between invoice factoring and invoice discounting as a financing method.

How Invoice Financing Works

Businesses are engaged in the selling of goods and services and the goods and services are mostly offered on credit. When dealing with customers and clients, businesses provide services or sell goods on credit and issue an invoice with a due date for a debtor to settle. 

However, the selling of goods or services on credit sometimes creates liquidity problems for a business. To address these liquidity problems,  businesses seek short-term financing from banks and other financial institutions. Businesses look for working capital from financial institutions to finance their invoices. 

Invoice finance comes in two ways. A business that is looking to finance its invoices may opt for invoice discounting or for invoice factoring as a method of financing. Invoice discounting is a type of financing where the borrower collects payments from its customers (due invoices) and then pays the lender the borrowed amount plus fees and interest incurred. 

On the other hand, invoice factoring is when the borrower sells its invoices to the lender with the lender collecting the due invoices on the behalf of the borrower. Borrowers can borrow up to 85% upfront of the invoice value, whereas with invoice discounting, borrowers can borrow up to 95% of the invoice value. 

What to consider

Factoring or Discounting Method

The first thing to do when considering invoice financing is to look into the options available to you as a consumer. You need to choose which method of financing is worthy for your business. Whether to choose the invoice factoring method or the discounting method will be based on the type of business you run. 

The lender will be in charge of collecting invoice payments if you use the factoring method. However, if the lender fails to deal with your debtors in a reasonable fashion, it may contribute to the loss of future business activity between your company and your customers.

The discounting method is the best solution for most businesses, however, the method has its own drawbacks. With the discounting method, your business will be dealing with the collection of amounts due. Your business will have to foot the administration bill of collecting money from debtors. 

Cash Flow statement review

The next step is to look into your finances if there is really a need for invoice financing or not. There are times when invoice financing can be a great deal, however, there are times when invoice financing can be a bad deal. 

 The cash flow statement will show you how much cash you need to run your business. This will assist in the creation of a budget, and your business will be able to determine how much it needs to financially cope through estimations.

Interest and Fees Associated with Invoice Financing

 The interest rate on invoice financing varies depending on the financial institution. Lenders also charge a fee when financing invoices; therefore, before using an invoice financing service, inquire about the fees and interest rates associated with funding. Lenders may charge hidden fees on a monthly basis, as well as one-time fees and high factoring fees.

Settlement Terms and Duration

Lenders offer early settlement discounts, so settlement terms are important to consider. When selecting a company to finance your business invoices, lenders who offer settlement discounts should be prioritized.

Traditional lenders usually give you between 30 and 90 days to pay off your debt. Extensions are available upon request. Along with other banks, fintech lenders have increased the term limit to 365 days. The settlement date should be prioritized based on the company’s financial projections.

Advantages of Invoice Financing

  • Businesses can get working capital for a fee when there is no liquidity in the business.
  • Companies can choose to collect invoices or get the lender to collect the invoice on the company’s behalf.
  • Obtaining an invoice finance loan can be simple because it is secured by collateral (invoices).
  • Using invoice factoring can save the borrower money because it eliminates admin fees and saves time.
  • Repayments are made when money is paid from invoices attached to the financing rather than through capital or other income.
  • Invoice Financing can be applied for in minutes and funds are available immediately upon approval.

Disadvantages of Invoice Financing

  • Invoice factoring as a method of Invoice financing can raise concerns among debtors about the company’s cash flow situation, and trust between parties may be jeopardized.
  • Fees and interest are a part of the financing. These will have a negative effect on the company’s profitability.
  • Companies may be locked into long contracts that require them to perform all types of invoice financing through a single lender.

Conclusion

Businesses need to stay liquid to survive and Invoice financing can provide a lifebuoy to insolvent businesses. Although illiquid times can cause agony in a business, knowing when to shop for invoice financing is crucial. 

Lethabo Ntsoane

Lethabo Ntsoane holds a Bachelors Degree in Accounting from the University of South Africa. He is a Financial Product commentator at Rateweb. He is an expect financial product analyst with years of experience in reviewing products and offering commentary. Lethabo majors in financial news, reviews and financial tips. He can be contacted at lethabo@rateweb.co.za

Published by
Lethabo Ntsoane