When customers owe your business money, it can take months for the cash to arrive – sometimes causing a cash flow problem. Invoice financing solves this problem.
What is invoice financing?
Invoice financing is when a lender buys your accounts receivables (invoices) or uses them as collateral to loan you money until the invoices are paid. This allows business owners like you to secure fast cash injections for growth or maintain cash flow in the business.
However, invoice financing has a significant drawback: it can compromise your customers’ confidentiality. If you want to avoid this issue, you might opt for a merchant cash advance instead! As long as your business processes sales using card payments, you can apply for a cash advance and receive up to $500,000 by tomorrow!
Benefits of an MCA from All Year Funding:
You can read more about our MCAs here. If you want to learn more about invoice financing, read on!
Why choose invoice financing?
For a business to operate effectively, cash flow is critical. Thus, some companies use invoice financing to secure money against their invoices. Although receivables financing is more expensive than bank loans, you can set up an account reasonably quickly, and lenders can generally deposit funds within 24 hours.
There are two main types of invoice financing:
- Invoice Factoring
- Invoice Discounting
We’ll discuss both types of invoice financing in detail below.
Invoice factoring is when a business sells a lender (called a factor) any outstanding invoice at a discount. Once the invoices have been sold, the factor is responsible for collecting them on their due date. The invoices are sold at a discount to lower the risk for the factor if invoices are not paid.
Businesses might use invoice factoring to access immediate cash flow. With factoring, all of the business’ invoices are usually sold.
How does accounts receivable factoring work?
- The business opens an account with a factor by filling out a ‘Factoring Application.’ Setting up an account with a factoring company can take 5 – 10 days.
- The business makes a sale or provides a service to another company and issues an invoice, usually payable in 30 – 90 days.
- Then, the business sends the factor the invoice, and the factor advances the agreed-upon percentage of the cash. This is typically between 75 – 90% of the invoice value. At this point, the funder takes ownership of the invoice.
- The factor collects the invoices from the end customers and sends the remaining income to the business, minus any fees. Factoring fees depend on the industry, customer strength, and the performance of the accounts.
What does a business need to qualify for invoice factoring?
Factors review every business on a case-by-case basis, but most will ask for:
How much is invoice factoring?
Factoring companies charge fees under two different categories:
- Invoice-related costs – On average, a factoring fee is between 1.5-5%. Sometimes, a factoring company will charge less for the first 30 days, for example: 1% to 3% for the first 30 days and 0.3% to 1% every ten days after that.
- Admin fees – These can include account set up fees, wire fees (usually about $25), mailing fees and monthly minimum volume fees (if you fail to sell your factor the minimum amount of agreed-upon invoices)
Invoice factoring with and without recourse
Recourse factoring protects the factoring company if receivables are not paid. With recourse factoring, the business must pay any delinquent receivables.
Non-recourse factoring releases your company from any liability if the receivables are not paid. Businesses will rarely opt for non-recourse factoring as the premiums are incredibly high. Moreover, non-recourse factoring usually requires your business to have an insurance policy to cover the factoring company in case of a receivable’s delinquency.
|Pros of invoice factoring:||Cons of invoice factoring:|
|Long term source of income||Secured form of credit|
|High approval rates and easy application process||Less confidentiality|
|Outsourcing invoice collection gives the business more time to focus on growing||Can interfere with business relationships|
|Businesses with bad credit can still be approved, as long as the end customer has good credit.||More expensive than bank business loans|
|Since factoring isn’t a loan, the business doesn’t incur debt for the money they receive from the funder.||Only available for B2B businesses|
Invoice discounting allows a business to receive funds soon after sending out an invoice. Unlike invoice factoring, invoice discounting is not a sale of your invoices. Instead, it allows you to borrow money to the value of your invoices, using the invoices as collateral. The lender provides you with a cash advance, and once the invoices are paid, you pay your lender back with interest. With invoice discounting, you maintain full control of your sales ledger, thereby keeping a higher level of confidentiality.
You can decide to discount a single invoice or a batch of invoices. Usually, with invoice discounting, only a selection or individual invoices are used as collateral, and not the whole book.
How does invoice discounting work?
- A business sends out an invoice to a customer, usually payable in 30 -120 days
- The business can then open an invoice or receivables finance line against the outstanding invoice.
- If the finance is approved, the funder will pay between 70-95% of the invoice value.
- The customer pays the invoice into the receivables account. If the discounting is confidential, this account will be in the business’s name. If the discounting is not confidential, the account will be in the funder’s name.
- Once the invoice is paid, the funder releases the remaining cash to the business, minus fees.
Benefits of invoice discounting
Invoice discounting is much simpler than a standard business loan in terms of the process and security offered. A business loan usually requires assets as security, while a discounting invoice facility focuses on the value of the invoice instead.
Also, clients and end customers need not know that you have a financing facility in place. Invoices can be discounted on a confidential basis, depending on what you agree with the funder. As a result, the customer would not know that there is a third party financier involved.
Lastly, unlike invoice factoring, businesses can choose when to discount invoices, which can match their funding requirements.
|Pros of invoice discounting:||Cons of invoice discounting:|
|Immediate cash advance||If invoices are not paid on time, it’s your responsibility to collect them|
|You stay in control of your ledger, maintaining a level of confidentiality.||Invoice discounting is more expensive than most other forms of business finance|
|Allows for immediate growth opportunities||Only available to B2B businesses|
What type of accounts receivable financing should you choose?
If you are a B2B business that issues large invoices but needs liquid cash to maintain cash flow, invoice financing could be the right financing option. If you are a B2C business or rely on credit card sales more than invoice payments, you might opt for a merchant cash advance instead.
Who is All Year Funding?
All Year Funding has been providing merchant cash advances in the US for over five years. We can purchase up to $500,000 of your future credit card sales today and have the funds transferred to your account by tomorrow! Our short application form takes just a couple of minutes to fill out, and a you’ll get an instant pre-qualification decision!
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