What is Invoice Finance and How Does it Work?

Invoice financing is similar to borrowing, which is usually in the short term. A lender or the bank generally gives it to the clients based on the number of invoices, which are not paid on time. Sometimes, when it becomes difficult for the company to operate due to a severe shortage of funds, invoice financing comes into play. It plays the role of meeting the company’s liquidity needs, thus allowing the company to survive. Although they are of short-term, invoice financing is exceptionally beneficial for the organizations. 

As discussed above, many companies raise invoices, but they don’t get timely payment from the customers, thus giving rise to a severe monetary crunch. Raising invoices implies accounts receivable, which suggests the organization will receive the money but not immediately. During such situations, many companies opt for invoice financing to sustain the period of the cash crunch. The money is used by the company to make payments to the suppliers or employees or to purchase new equipment. 

Invoice financing can be classified into two types, which are Invoice Factoring and Invoice Discounting. Well, invoice financing is very advantageous, and it can fetch thrice as much cash as one can get with any traditional sources of funding. Does this give a clearer insight into invoice financing? Also, with invoice financing, the borrowing power of the companies grow, which indicates an eventual growth for the companies. 

How does Invoice Finance operate?

Firstly, with invoice financing, there is no change in the operation of the companies. They continue with their business following a regular course and also raise invoices for their clients accordingly.

Next, the companies share the same invoice with the third party who has agreed to purchase them and thus financing the invoices.

Once the invoices are passed on, the financer pays an amount to the company based on an agreed percentage, and this takes place within 48 hours

Based on the agreed terms, either the company or the provider keeps a close follow-up on the payments

Once the payment is made, the company will receive the balance minus service tax if any

On the one hand, some providers can finance the entire sales ledger, while some can fund only a particular invoice. Better known as spot financing, such a finance facility is ideal for companies that generate a relatively fewer number of invoices, but they are of more massive amounts.

Advantages of Invoice Financing

  • Unlike overdraft facilities or business loans, invoice financing are better as they are more flexible
  • With invoice financing, much quicker lending decisions can be made
  • The funding and the turnover grow hand in hand
  • Typically, borrowing levels are expected to be higher when it comes to the borrowing of assets
  • Companies prefer invoice financing because it minimizes the chances of defaulted invoice

What is the cost associated with Invoice Financing?

Before opting for invoice financing, the companies must comprehend all the fees and costs associated with the financing process. Understanding the values is essential to understand the hidden charges, if any.

A standard invoice financing generally includes the following charges:

The Service Charge: It consists of the administrative costs and usually levied based on the gross turnover of the company. A typical percentage of service charge hovers somewhere between 0.75 and can go up to 2.5%.

The Discount Charge: Typically, a discount charge accounts for a percentage of 1 to 3 and is the money, which is levied on the withdrawn money. As discount charges are calculated every day depending on the monetary advances; hence, it suggests the companies have to bear more costs if the client takes a higher number of days to pay. 

Are all Companies eligible for Invoice Financing?

Some of the standard requirements for a company to be eligible for availing invoice financing are stated as under:

The company maintains a trading relationship with other companies

The company that wishes to opt for invoice financing is LLP, i.e., limited company;

The company provides standardized credit terms,

Some providers offer invoice financing to companies that attain the number of invoices every day as per the specification of the provider.

Invoice financing proves to be beneficial and therefore, has made its place in the financial world.

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Nancy G.

Former head of accounting at a tax consultancy firm, loves to spend time with her grandchildren and husband. Also a dog lover.

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