Invoice financing is a loan that businesses seek from funding companies on the basis of the payments that customers have not made. In other words, in order to collect payment, businesses send invoice to customers. On the basis of this invoice, the business can opt for financial aid.
Putting it simply, it is a loan against the invoice, which acts as collateral or security for the lending or the funding company. This is an excellent avenue of financial aid particularly for companies that want to improve their cash flow. With the help of the cash, businesses can make payment of salaries of the employees, reinvest inappropriate avenues in areas like operations and growth.
Structuring invoice financing
Basically, invoice financing can be in form of ‘factoring’ or ‘discounting’. In case of the former, the business sells the invoices to the funding company, which in turn will make payment for 75% to 80% of the value of the outstanding invoice. This is usually paid upfront. The rest of the payment is made when the outstanding amount is collected from the customers.
In case of the latter, the business will collect the outstanding payment from customers and not the lenders. Invoice discounting can earn upto 85% of the outstanding invoice amount from the lender. Once the customers make the required payment against the invoices, the business that has received financial aid from the funding company repays the amount after financial adjustments in form of fees.
Benefits of invoice financing
Given below are the benefits-
- Generally, it has been observed that not all lending companies want to deal with new business identities since there is a lot of risk involved. This is because it might be a loss venture for the funding company as a startup’s flow of cash may not be consistent or certain. For such startups, invoice financing is an excellent avenue for the ball to keep rolling.
- With the quick disbursal and prompt loan procedure, cashflow is maintained well, which in turn might help the businesses to procure necessary equipments and tools required for the growth or expansion of the company.
- Startups usually face a problem of due collection. This can be taken care of by the lending company. There are many lending companies that will collect the outstanding invoice amount directly from the customers, thereby acting as collection agencies.
Drawbacks of invoice financing
The drawbacks are as follows.
- Many business identities have complained about the cost of the loan, which is quite significant. The yearly rate of interest may range between 12% and 60%. Aside from this the fee is between 1% and 5%. As such, unless you can maintain the collection of outstanding invoice amount and abide by the norms, you might end up paying an astronomical amount by the time, you have wrapped up with the loan.
- Although, invoice financing is an excellent way to lay your hands on extra cash against the invoice, it may not be appropriate for all businesses. Individuals will not benefit much from the loan concept and not all businesses might qualify for the loan process.