Invoice financing allows a small business to take out a loan based on its unpaid invoices. It’s typically a fast way to get funding and can be easier to qualify for than other loan options, but it’s also a fairly expensive solution.
Invoice financing is sometimes confused with invoice factoring, but it’s important to understand the difference. Invoice factoring involves selling your unpaid invoices to a factoring company, whereas with invoice financing, you maintain control over your invoices and are responsible for collecting payments on them.
Invoice financing — also known as accounts receivable financing, invoice discounting or receivables financing — is a type of small business funding where a company borrows money using its outstanding invoices as collateral. It’s essentially a cash advance based on a percentage of your unpaid invoices, which you’ll repay when your customers settle their bills.
Invoice financing offers a fast influx of capital often used to handle immediate cash flow needs, such as covering payroll or purchasing inventory. It’s also typically easier to qualify for compared to more traditional loans. Plus, it allows business owners to take advantage of time-sensitive opportunities without going through a lengthy lending process.
Invoice financing basically works in three steps.
For a simple example, let’s assume you have an outstanding invoice of $100,000. You submit it to a lender that agrees to extend you a loan of $90,000 — 90% of the invoice total — at an interest rate of 5% of the loan amount. When you repay the loan within the agreed-upon timeframe, you’ll owe $94,500 ($90,000 loan amount + $4,500 in interest).
Invoice financing is typically a more expensive form of financing than more traditional business loans. While exact fee structures depend on the lender, you might expect to pay an interest rate between 1% and 5% of the loan amount. Some lenders may charge a rate based on the face value of the invoice.
A rate of 5% may seem reasonable, but when you factor in that invoice financing is typically a very short-term loan, the effective APRs can reach well into the double digits.
Plus, keep in mind that some invoice financing lenders may also charge fees on top of interest, such as application or administrative fees. In addition, you’ll be on the hook for late fees if your customer doesn’t pay on time and you don’t have enough to cover the payment. To keep costs down, it’s critical to only finance invoices from customers that always pay on time.
Invoice financing makes the most sense for small businesses with a lot of cash flow. More specifically, invoice financing is ideal for business-to-business (B2B) firms or companies with a steady stream of reliable, repeat clients.
Not every business is suitable for invoice financing, so you’ll want to assess your business and consider your loan options.
Lenders consider these factors to determine if you qualify for invoice financing:
Invoice financing is often confused with invoice factoring, but there are some key differences. While both financing options consider your invoices to qualify, invoice factoring involves selling your outstanding invoices to a factoring company, whereas invoice financing allows you to retain control over your invoices.
A factoring company takes possession of your invoices, pays you a percentage of the invoices’ value and handles the collection process. Once a customer pays, the factoring company sends you the difference minus its fees.
Invoice factoring might make sense if you don’t mind having someone else handle the collection process and aren’t worried that using a third party will harm your connection with customers. However, if you prefer to maintain close relationships with your customers, invoice financing might be a better choice.
Invoice factoring is one alternative to invoice financing, but it’s not your only option.
If you’re a small business owner with a lot of invoiced customers, invoice financing might be a good solution. It can help cover cash flow shortages or take advantage of growth opportunities. Funding is typically fast, and your loan is secured by your customers’ invoices.
But it is an expensive form of short-term funding, and it’s not feasible for all types of businesses. If invoicing financing doesn’t work for your company, consider other business loans or alternative forms of business funding.
Not all invoices are necessarily eligible for financing. Your lender assesses your invoices and lets you know which ones qualify. For example, a customer with an invoice history of late payments may not be eligible for financing.
Aside from providing your customer invoices for approval, you may need to provide other documentation, such as recent bank statements, personal and business credit scores, tax returns or business financial statements.
In most cases, you need to provide your account details to lenders. Most are online lenders and need your banking information to deposit your funds electronically. Lenders may also want to look at your business bank account to view your balance and transaction history.
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