What is Invoice Financing?
Invoice Financing (discounting) is a short-term solution to borrow money to improve the company’s cash flow: A business borrows on invoices before customer payment.
It is a fine way to seek a loan based on customer revenue due from sales before payment. The financing will help a business pay employees, suppliers, re-invest in the company, and improve cash flow, sooner than waiting for customer payment.
The lender will take a percentage of the invoice amount as a fee. The most common reason for taking Invoice Financing as a solution is because it solves many of the short-term problems associated when customers delay payment for a sustained period and the company has difficulty obtaining any other form of business finance or credit.
It’s Structured and Secure
Lenders benefit from invoice financing because it is structured as a secured line of credit. Invoices act as collateral against money borrowed. This makes it different from an unsecured line of credit, which leaves the lender little recourse if the borrower defaults on payment.
The lender further limits the risk by lending only a percentage of the total invoice amount; the balance acts as a fee. The biggest risk to the lender is the customer’s willingness to pay. If a client is unable or unwilling, the lender is basically left as the creditor rather than the company.
The most common ways to structure invoice financing is by discounting or factoring.
The company will sell its outstanding invoices to the finance house who in turn will pay a cash sum of say 75% to 85% of the total worth. Once (assuming) the lender receives full payment from the customers, they will remit the balance of 15% to 25% of the invoice amount, less the interest or fee for the service. Customers are always made aware of the funding arrangement.
In this financial arrangement, the customers will not be made aware of the deal between the company and the lender. The lender advances up to 90% of the total invoice amount, and the company collects payment from the customers. The loan is repaid and the lender takes a fee after the customers have paid their invoices.
Pros and Cons of Invoice Financing
- An immediate option.
- Property security is not required.
- A good option for New Businesses: Non-Bank Lenders are more flexible in their lending practices than formal Banks.
- Invoice Finance is a confidential lending opportunity; customers are not apprised of the arrangement between lender and company.
- Interest is only payable on the borrowed amount.
- Invoice Finance loans are based only on “Invoices” and not cash payments and, only on a business-to-business relationship. Credit card and EFTPOS payments are not eligible as a form of payment guarantee.
- The invoices become an asset of the finance company. The invoice/accounts receivable ledger is no longer usable by the company as collateral for other forms of funding.