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Home Business Loans What Is Invoice Financing And Is It Right For Your Business?
In today’s fast-paced business world, companies are always looking for ways to access capital quickly and efficiently. One option that has become increasingly popular is invoice financing. This lending method allows companies to use their outstanding invoices as collateral to secure a loan, providing them with the funds they need to cover operating expenses, payroll, and other costs associated with running a business. In this article, we’ll take a closer look at how invoice financing works, its requirements, costs, pros and cons, and how it differs from invoice factoring.
Invoice financing, also called accounts receivable financing, is a lending method in which a company uses its outstanding invoices as collateral to secure a loan. Normally, lenders require some sort of company asset to act as collateral. However, with invoice financing, unpaid invoices are the asset. This process is usually faster than other small business loans, both in terms of application and receipt of funds.
One thing businesses should keep in mind about invoice financing is that the full invoice amount is not given. While it depends on the lender, companies are typically only able to borrow up to 80% of their accounts receivables.
To qualify for invoice financing, businesses need to meet a set of specific criteria. First and foremost, your business must have outstanding invoices from reputable clients, as these will act as your collateral. Generally, lenders prefer invoices due to be paid within 90 days.
Second, it’s crucial that your business has a solid track record of successful transactions with its clients. High levels of disputes or returns can raise red flags for lenders. In other words, a history of strong customer relationships can make your business more attractive to lenders.
Third, many lenders also require a minimum monthly revenue of $10,000 to qualify, ensuring a steady cash flow and loan repayment capability.
Finally, industry preference is also another factor that lenders consider. Some sectors are more favorable to lenders due to the predictability of their cash flow and lower risk levels. However, this varies by lender and it’s always best to check with your potential lender about their preferred industries.
Remember, each lender may have their own set of requirements, so be sure to do your research and understand the terms before you apply.
Here’s what to expect with invoice financing. Once approved, you’ll receive a cash advance based on a percentage of the outstanding invoice (usually around 80%). You can use those funds for whatever operating expenses you need, such as payroll or inventory. When your customer pays the outstanding invoice, you pay the lender back along with the agreed-upon fee.
Let’s explore a concrete example to better understand the process of invoice financing:
Imagine you own a small tech company, “Bright Future Tech,” and you’ve recently completed a large project for one of your clients. The client is happy with the work, but they operate on a net 60 payment term. That means you won’t see the payment for two months, but you have bills that need to be paid now.
Bright Future Tech has an outstanding invoice of $100,000 from the client. You approach a lender for invoice financing. The lender agrees to provide you with 80% of the outstanding invoice amount, which is $80,000. This cash advance helps you to manage your immediate operational costs.
After two months, when your client pays the invoice in full, you then repay the lender the $80,000 you received upfront, plus any fees associated with the loan. In the end, invoice financing has enabled your business to maintain a healthy cash flow, despite the lengthy payment terms of your clients.
You do have to pay the invoice financing company for getting the advance. Instead of a factoring fee (as you’d pay with invoice factoring), you’ll pay an ongoing percentage of the invoice amount until your customer pays.
For instance, your financing terms might have you pay 3% of the outstanding invoice every month. On a $10,000 invoice, that would be $300 per month. These costs can quickly add up if your customer is extremely late in paying.
Companies in need of working capital—or who need help financing a purchase order—may find their borrowing needs met with invoice financing. However, there are other loan products on the market that may be a better fit. When choosing an invoice financing lender, make sure to compare its rates and fees with its competitors to ensure you get the best one.
Invoice financing can be used to cover any of a company’s working capital needs. Companies that utilize invoice financing typically use it for things like:
Businesses typically use invoice financing to cover their operating expenses (i.e., costs of being in business or expenses that enable a company to generate revenue). However, it’s not uncommon for companies to also use invoice financing to help with growth or expansion.
You’re only able to borrow against your company’s accounts receivables. While the amount that can be borrowed depends on the lender, most companies are only willing to lend up to 80% of the invoice amount.
Lenders typically charge between 1% and 5% of the invoice amount each month. This means the total amount you’ll pay depends on the loan amount and the time it takes your customer to pay.
With invoice financing, your company is still in charge of collecting payment from your customers. In most situations, the lender does not contact customers.
With invoice factoring, a third-party company buys an unpaid invoice for an amount less than the invoice total. That company then seeks out the payment from the customer. Once full payment is received, the third-party company pays the original company any remaining amount from the invoice, minus any fees.
Invoice financing is very similar, only the responsibility for collecting on the invoice stays with the company, rather than moving to the lender.
Ready to get paid sooner? Apply for accounts receivable financing today with Lendio.
Applying is free and won’t impact your credit.
Lauren Ward is a personal finance and tech writer with a passion to help consumers make smart financial decisions. Her work has appeared in a variety of publications, including Time and MSN. When she's not writing, she loves gardening and playing board games with her family.
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