If you are looking for a way to obtain much-needed cash for your business, invoice financing may be a good option. Invoice financing lets businesses borrow capital from their unpaid customer invoices. This type of financing can make sense if you need to manage cash flow issues, pay short-term expenses, or don’t qualify for a small-business loan.
Here’s what Omni Capital would like you to know about invoice financing, how it works and if it is right for your business.
What Is Invoice Financing?
Invoice financing is a cash advance that small-business owners can receive on their outstanding customer invoices. This type of business loan is also sometimes known as accounts receivable financing or invoice discounting. A small business will work with a lender to provide unpaid invoices as collateral in exchange for access to immediate cash. This can make invoice financing easier to qualify for than other small-business loans. It’s important to note that you still own the unpaid invoices and remain responsible for collecting payment on them.
There are two types of financing that allow you to use your unpaid invoices to access capital for your business – invoice financing and invoice factoring. A key difference between these two types is technically, invoice factoring is not a loan. You sell your unpaid invoices at a discount to a factoring company in exchange for a lump sum of cash. The factoring company then owns the invoices and gets paid when it collects from your customers, typically in 30 to 90 days.
How Does Invoice Financing Work?
With invoice financing, lenders advance a percentage of your unpaid invoice amount — potentially as much as 90%. When your customer pays the invoice, you receive the remaining percentage, minus the company’s fees. Invoice financing companies can charge fees in different ways, but usually they charge a flat percentage (1% to 5%) of the invoice value.
An invoice financing arrangement involves three parties: the business that issues an invoice, the customer that receives the invoice and the financial services company. To get the maximum benefit from this type of receivables financing, a business must negotiate terms with the financing company and hope that its customer pays by the due date on the invoice.
Invoice financing arrangements have some similarities to short-term loans. In its simplest form, invoice financing would be based on a single invoice, or account receivable. With that invoice serving as collateral, a financial company operating as the lender advances cash to the business that owns the invoice. When the business gets paid, the business sends the original loan amount back to the financial company, along with interest based on the length of time the loan has been outstanding.
To apply for invoice financing, you may need to provide:
- Basic information about your business
- Business bank statements
- Business financial statements, such as an accounts receivable aging report
- Invoices you’d like to finance
- Personal and business credit scores
Pros and Cons of Invoice Financing
Invoice financing can be immensely valuable to companies, allowing them to continue operating during periods of constrained cash flow and to pursue potentially fortune-changing opportunities. But it also has some drawbacks. Business owners should understand both sides before deciding whether to use invoice financing.
- Fast cash. Invoice financing companies usually offer simple applications with minimal documentation and can sometimes provide funding, in as little as 24 hours, on revenues you’ve earned but have not yet collected. Invoice financing can reduce an owner’s worry about cashflow and allow management teams to proceed with important initiatives that they would otherwise have to forgo.
- Ideal for business-to-business companies and seasonal operations. Invoice financing works best for businesses that primarily deal with other businesses since outstanding invoices are necessary to obtain funding. Invoice financing can help these types of businesses alleviate cash flow issues due to unpaid invoices.
- Invoices serve as collateral. Because invoice financing is backed by your invoices, it can be easier to qualify for compared to other types of business loans. Lenders typically consider your customers’ payment history when evaluating applications.
- Highly valuable in an emergency. Natural disasters that result in damaged inventory, a disruption involving a key supplier or the bankruptcy of a key customer — developments like these can quickly put companies in survival mode. If a business finds itself facing one of these threats and doesn’t have a lot of money in the bank, the rapid cash provided by invoice financing can be company-saving.
- Relatively light approval process. Many young and growing companies don’t have the necessary credit ratings to secure bank loans and lines of credit. This doesn’t matter as much to companies that provide invoice financing because they are more concerned about the credit rating of company’s customers than about the business itself. A business applying for a cash advance on its invoices will typically face less paperwork and fewer questions.
- Alleviates cash flow problems due to slow-paying customers. It can be extremely frustrating to wait on payments from customers who are slow to pay, especially if they make up a large part of your company’s accounts receivable balance. Invoice financing can provide a sense of regularity to the collections process and reduce problems caused by late-paying customers.
- Easier to qualify for than a loan. This ease of access is especially important for small businesses that haven’t been open long enough to generate credit or that have financial problems. Invoice financing doesn’t require a credit check on the business or its owners. Instead, financing is granted based on the value of the invoices and the customer’s history of payment.
- Lower cost if customer pays on time. If you have customers who pay their bills on time, the cost of invoice financing will be relatively low. There will be no need for excess efforts by the lender or your company to collect payments from a customer on your behalf.
- Reliance on customer payments. The amount you pay in fees is based on how long it takes your customer to pay the invoice, so it is difficult to estimate the total cost of invoice financing upfront. If your customer is late or misses a payment, an invoice financing company may charge late or additional fees. You face bigger risks if your customer doesn’t make payments altogether.
- Limited applicability. Not all businesses are able to use invoice financing. For it to make sense, a business must be in a business-to-business (B2B) sector. Since businesses that sell to consumers typically collect payment at the point of sale, invoice financing is usually not available to them. These types of companies will need to consider other types of financing if they encounter cash flow difficulties.
- Can be more expensive than other loans. The processing fees and weekly interest rates can result in APRs that are higher than what a business would ordinarily pay for a bank loan.
- Difficult to Evaluate Upfront Costs. Since the cost of invoice financing is determined by the length of time it takes a customer to pay, it can be difficult to conclude how much it will ultimately cost. A longer-than-contracted delay in payment can wipe out any profit from a sale.
Is invoice Financing Right for Your Business?
Deciding whether invoice financing is right for your business requires a lot of consideration. It is important to have a clear understanding of your customers’ paying habits and of lenders’ invoice financing agreements. You should have an awareness of how much invoice financing will cost your business and if it will impact relationships with your customers.
The key points to note when deciding if invoice financing is right for you:
- Invoice financing allows businesses to borrow money against their pending accounts receivable.
- Businesses typically opt for invoice financing when they are facing a cash shortage or temporary cash-flow problem.
- Invoice financing is more expensive than traditional bank financing, but it requires significantly less paperwork and can usually be secured much quicker.
- Invoice financing makes most sense for businesses that have well-known customers who pay their bills on time.
- It is not an option for B2C businesses; it’s only applicable in B2B sectors.
Every company needs cash to fund its operations. You need to pay for materials, distribution, rent and payroll, to name just a few necessities. Companies with bank loans or lines of credit can take advantage of them during periods of slow cash flow. Companies that need cash quickly or can’t secure a traditional bank loan sometimes turn to receivables financing – a loan to the business based on revenues earned but not yet collected. For some companies the cash they receive, often within a day or two, can provide essential liquidity until they have a more comfortable cash cushion.
Contact a funding professional at Omni Capital to determine if invoice financing can help your business NOW!