Often called the ‘debtor financing’, ‘spot factoring’ or ‘invoice discounting’. Invoice financing is a process involving short term borrowing for the purpose of increasing the cash flow position of a company. Invoice financing is often confused with debt factoring, which has an absolutely different financial arrangement.
In other words. the whole concept of invoice finance can be summed up in the following statement. “In order to raise a required amount of cash, you as the owner of a particular business, call upon a financier to sell your credit invoices. The financier in return pays you money immediately, while the customer pays the financier later.”
How Does Invoice Financing Work For Businesses?
There are three steps:
- The business draws money against the potential sales. The business draws the money before receiving the final payment from the customer. In simpler terms, the business borrows a percentage value of the total sales ledger from a finance company. Here, the “potential sales” that have not yet been paid for are used as a collateral for borrowing.
- The financial company charges for this service on a monthly basis. There’s also a pre-defined rate of interest applied on the amount that’s borrowed against sales’ invoice. They can also refuse to lend against invoices in certain cases.
Examples include when the customer:
-sells to overseas companies
-involves credit risk
-undertakes sales having long credit terms
-small value invoicesDuring this period, the finance company can demand records of the ongoing credit sales process. They can also demand the sales ledger from the business.
- The business raises the invoice. The business can then borrow a percentage of the invoice value as a fee. The percentage is generally 80 percent in most cases.
What Are Some Key Benefits Of Invoice Financing?
- One of the major problems businesses face is the late payment of all invoices. The process of chasing the outstanding invoices is not only time consuming, but also adversely affects the customer-business relationship.
- To avoid this, invoice financing supports outsourced credit control. This allows the business owners to concentrate more on product development and customer satisfaction.
- Invoice financing promotes better management of sales ledger, leading to shortening of payment cycles.
- Businesses availing invoice financing can pay rents, salaries, taxes and other bills regularly. They will be capable of preparing for the unexpected.
- The most convenient thing about invoice financing is that it’s quite similar to an overdraft. The businesses only have to pay for the interest on the funds they borrow. This makes the whole process more flexible and user friendly than debt factoring.
- You can arrange confidential invoice financing. This means that suppliers and customers aren’t notified about the business using sales’ invoices to borrow cash without paying them first.
What Are Some Key Drawbacks Of Invoice Financing?
- In the corporate world, companies in financial debt are in a financial crisis. This information may lead to suppliers being constantly reluctant to provide appropriate credit terms, negating the most common benefits of invoice financing.
- Once the company or business starts depending excessively on the improved cash flow caused by invoice financing, it becomes increasingly difficult for the business to get out of the invoice financing arrangement. You will come across a lot of businesses that turn to invoice financing for capital support in the beginning, and then end up using it for a prolonged period of time.
- While providing invoice financing, the finance company you are dealing with tends to take legal charge of the sales ledger as a part of the whole process. This leaves the businesses with fewer assets to show for as collateral. This makes it more expensive and difficult for them to take out other loans. Even with all the benefits it may come with, invoice financing can cost more than an overdraft or a simple bank loan.
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