Invoice financing is a The way for businesses to borrow against unpaid invoices. With invoice financing, sometimes called accounts receivable financing, you sell accounts receivable to a lender instead of waiting for customers to pay their invoices.
You can get paid immediately, but this financing option has its downsides. Read on to see how invoice financing works and whether it is a good idea for businesses that need funding.
What is the meaning of an invoice?
Invoice financing is a term that applies to products that reduce the financial pressure of waiting for customers to pay their invoices.
Bob Castaneda, director of accounting and finance programs at Walden University, says companies use invoices to shorten their cash conversion cycles, or require them to convert their investments into cash.
This short term lending solution “helps companies to fund theirs working capital Such as employees, suppliers and other vendors need to be paid, says Castaneda, without worrying about when customers pay.
Invoice financing includes both invoice factoring and invoice discounting. The difference between invoice factoring and invoice discounting is that which collects payments from the customer.
You will collect payments as usual from your customers with an invoice discount, but the lender collects from your customers with invoice factoring and may charge more for it. Here is more information about this type of invoice financing.
Your company sells control of your accounts receivable to the lender, at a discount, for quick cash. Once customers pay your balance, you may receive 70% to 90% of the value of your invoice and the remaining balance, minus a fee.
The downside to invoice factoring other than fees is that your customers pay directly to the lender. You no longer have control of the collection process, and your customers know that you are financing their invoices.
The lender typically advances your business for 80% to 90% of the invoice amount, says Dan Karas, executive vice president of affiliate funding, a division of Allied Bank NA. Once your customer pays the invoice, you will pay the lender and receive the remaining value of the invoice, minus the service charge.
What is an Invoice Finance Agreement?
An invoice finance agreement is a contract that details the terms of the arrangement between the lender, or the factor and the business. A factor, or factoring company, is a funding source for the purchase of accounts receivable.
The agreement includes several issues. “The names of the party, who is responsible for what actions, the time and dollar amounts are covered in the agreement, as well as how the lender or factoring agent will be compensated,” Castaneda says.
The primary components of an invoice finance agreement, essentially a purchase and sale agreement, are advance rates, fees, and whether sold with or without an invoice, Karas says.
He says, “Recorcation is the practice where the business and invoice finance company agree how long the buyer will have before the businessman returns the invoice.” “The time from the date of the invoice is usually 90 to 120 days, although the terms vary depending on the client’s business model.”
If the invoice is purchased without repetition, the factoring company absorbs the loss if the customer is not paid. Recurring factoring is more common and means that your business should reduce invoice repayments. Factoring without intercourse often leads to higher fees because the risk is greater for the lender.
How much does the invoice cost?
Invoice financing can come with some heavy fees. Finance fees will vary depending on factors such as the average time your customers pay an invoice, the credit quality of your customers, and the terms of your invoice finance contract.
You can not only pay service charges, but also charge interest on your balance. Application and termination fees may apply, as well as late payment fees that may increase your interest rate.
Many lenders offer online calculators to help you determine the potential cost of invoice financing.
What are some invoice financing companies?
Many companies offer invoice financing. Here are some of the main ones:
- American Receivables, which also provides Credit lines Up to $ 5 million and allows your business to choose invoices for finance
- Bluevine, Which extends credit lines up to $ 5 million and allows businesses to select invoices at rates starting at 0.25% per week
- Paragon Financial, which pays 80% to 90% of the invoice value depending on your industry and your funding arrangements
- Fast finance, Which offers invoice factoring of up to $ 10 million
- RTS Financial, which specializes in invoice factoring for trucking companies with an upfront rate of 97%.
- TCI Financial, which typically advances 90% of invoices with month-to-month or long-term contract options
Traditional lenders can also provide invoice financing. The advantage of a traditional lender is that it is a direct source of funds, which may mean lower borrowing costs than an invoice financing company.
- Us bank Invoice Financing through its partner, LSQ, which advances unpaid invoices up to 90% for same-day funding.
- A division of Southern Bank called Altline provides invoice financing services.
Is invoice financing a good idea?
Invoice financing can mean that a business is desperate for cash, but this is not always the case. Sometimes this is a good idea.
“One of the biggest constraints on growth and stability for businesses and nonprofits is the cash flow for bill payments,” Castaneda says. “This is a good way for invoice financing organizations to convert sales or revenue back into accounts receivable into cash to meet further needs.”
The lender, or factoring company, helps the borrower by managing bookkeeping and collections of sales and provides continued access to cash, he says.
Karas said invoice financing also allows businesses that are not eligible for traditional financing to better manage their working capital needs. It is ideal for industries such as trucking and temporary staffing, who may have to pay employees weekly, but often have to wait 30, 60 or 90 days to collect invoices from customers.
“Other features that make invoice financing a suitable tool is whether a business has a high debtor concentration,” says Karas.
Debt concentration refers to the percentage of your accounts receivable by a debtor or customer. A high debtor concentration typically means a less diversified customer mix and a much higher risk for traditional bank lending.
But invoice financing companies are primarily concerned that the invoice is verified, the goods are delivered and payment will be made.
Invoice financing is not without its downside, however.
The type of financing you choose can mean losing control of your invoices and your customer experience. Customers may not appreciate that their invoices were sold to a third party, and poor collection practices can damage your brand image.
There is no guarantee that customers will pay their invoices in full or on time. If they ignore your invoice, the factoring company may ask you to differentiate or charge late payment fees, which may already be an expensive service.