Invoice Financing

What Is Invoice Financing?

Invoice financing is a form of asset-based financing in which business owners receive an advance of capital in exchange for their unpaid invoices. Typically, invoice financing companies can advance you up to 85% of the value of your invoices and you receive the remaining 15% (minus fees) when your invoices are paid.

Invoice Financing Details

Pros

• Fast access to working capital
• Alleviates cash flow problems due to unpaid invoices
• Easier to qualify for than other types of business financing
• Invoices themselves serve as collateral
• Low cost if your customers pay on time

Cons

• Can have higher fees than other types of financing
• Difficult to evaluate cost upfront since fees are based on time it takes customer to pay
• Can be expensive and risky if customers are late to pay, or don’t pay at all
• Specific to B2B and other invoice-based businesses, not really an option for most B2C businesses

How Does Invoice Financing Work?

Whereas many business financing products are structured as term loans, (where you receive a lump sum of capital that you pay back, with interest, over time), invoice financing is different. As we mentioned in the definition above, invoice financing is a form of asset-based financing—in which you receive an advance of capital for your unpaid invoices.

This being said, although it’s possible to receive up to 100% of the value of your unpaid invoices, most invoice financing companies will advance you up to 85%, holding the remaining 15% until the invoices are paid.

When your customer pays the invoice, you receive the remaining 15%, minus the lender’s fees. Typically, you’ll be charged a processing fee (about 3%), as well as a factor fee. The factor fee, usually about 1% to 2%, is charged on the total value of the invoice for each week it takes the customer to pay.

With invoice financing, therefore, you pay for fast and immediate access to your capital, freeing up your cash flow that’s being held up in unpaid invoices.

Invoice Financing Example

Let’s say you have a $100,000 invoice with 30-day terms.

You find a financing company that’s willing to advance you 85% of that amount—$85,000—and hold the remaining $15,000 in reserve.

The company is going to charge a 1% factor rate for each week it takes the customer to pay the invoice, as well as a 3% processing fee. In this case, it takes the customer two weeks to pay the invoice, so you’ll be paying 2% in factoring fees ($2,000), plus the 3% ($3,000) processing fee.

Therefore, of the $15,000 held in reserve by the financing company, you’ll only receive $10,000 ($15,000 – $5,000 in fees). All in all, you’ve paid 5% in fees, $5,000 of the original invoice amount, to get early access to your capital before the customer paid the invoice.

Types of Invoice Financing

Although invoice financing usually works as we’ve just described, there are a few variations on this form of funding—including invoice factoring and accounts receivable lines of credit—that are important to explain.

Invoice Factoring

Invoice factoring and invoice financing are often used interchangeably, however, there are differences between these two types of funding. In short, invoice factoring is a type of invoice financing and functions much in the same way, where a lender advances you capital that is collateralized by your unpaid invoices.

The difference, however, is that with invoice factoring, you’re actually selling your invoices to the invoice factoring company. In this way, whereas traditional invoice financing means you pay back the advance of capital you borrowed, plus fees, invoice factoring means you’re selling your invoices to a factoring company at a discount.

In most cases, this also means that the invoice factoring company is the one collecting payments from your customers.

Accounts Receivable Line of Credit

An accounts receivable line of credit, on the other hand, is a type of invoice financing in which you use your unpaid invoices to finance a credit line. In this case, the line of credit is backed by your invoices and the amount you receive on the line is usually up to 85% of the value of those invoices.

Unlike traditional invoice financing or invoice factoring, however, where you’re given a full advance of the value of your invoices, in this case, you have access to a credit line that you can draw from as needed—just like any other business line of credit.

With an accounts receivable line of credit, therefore, you pay an interest rate based on your balance, and when a customer pays their invoice, the amount is deducted from your current balance. In addition, some lenders will charge you a draw fee, every time you pull on the credit line.

This being said, in most cases an accounts receivable line of credit is like traditional invoice financing (as opposed to factoring), in which you retain ownership of your invoices and are responsible for collecting customer payments.