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A Guide to Invoice Financing for Small Business

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Small business owners can often find themselves in a tricky position when their customers take too long to pay invoices. To free up some working capital, many turn to small business loan lenders as a way to bridge temporary cash flow shortages. This kind of invoice financing works well for both parties, allowing businesses to keep running smoothly while providing customers with flexible payment options.

What Is Invoice Financing?

Invoice financing is a type of business loan that’s made based on the value of your outstanding invoices. Lenders who offer invoice financing for small business typically don’t loan the full amount of the invoices, but they do loan a large percentage of their value, helping business owners get enough money to keep their business going until the customers pay their bills. This financing method is more commonly used by B2B companies rather than companies that deal with individuals.

Invoice Financing Explained

By leveraging these invoices, businesses can access immediate cash flow to address their financial needs. Whether it’s to cover operating expenses, invest in growth opportunities, or manage seasonal fluctuations, invoice financing provides a solution that can help businesses maintain a healthy cash flow.

It offers a more accessible alternative to traditional loans, as the focus is on the creditworthiness of the customers rather than the business itself.

How Does Invoice Financing Work?

Invoice financing is a funding solution that allows businesses to access immediate cash flow by using their outstanding invoices as collateral. Rather than waiting for customers to pay their invoices, businesses can sell them to a financing company at a discounted rate.

This provides businesses with a quick injection of cash that can be used for various purposes, such as covering operational expenses or investing in growth opportunities. Once the customer pays the invoice, the financing company deducts their fees and returns the remaining balance to the business.

Invoice Financing vs. Invoice Factoring

Invoice financing and invoice factoring are two similar types of business financing, but they aren’t exactly the same. With invoice factoring, your outstanding invoices are sold at a discount to a third party known as a factor. The factor then becomes responsible for collecting payment from your customers. Once the factor is paid by your customers, the factor pays you back the difference between the amount they advanced you and the full value of the invoices, minus a factoring fee.

If you choose invoice financing for your small business, your outstanding invoices are simply used as collateral for a loan. Your customers still pay you as they normally would and you repay the financing company according to your agreed-upon schedule until the amount of the loan has been paid off, plus any applicable fees.

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Pros and Cons of Invoice Financing for Small Business

In the case of invoice financing, the invoices themselves serve as collateral so there is no need to provide any other types of assets to secure the funding. This can be particularly helpful to smaller businesses that do not own major assets.

Invoice financing is much faster and easier to apply for than regular business loans, so it can provide you with some extra working capital without having to deal with long applications or having to wait a long time to find out if you’ve been approved. The approval process for small business invoice financing is usually completed in a matter of days, not weeks or months.

Invoice factoring can also be an option for newer businesses and businesses that don’t have ideal credit scores since lenders focus more on your invoices and your customers and less on your credit score.

Although lenders typically don’t advance the full value of your outstanding invoices, they generally finance a large percentage of their value, often as high as 80% or 90%.

Since invoice factoring is a type of short-term financing, interest rates can be higher than they would be with a more long-term business loan.

Not all types of invoices may be eligible for financing. Generally, lenders who offer it will only be interested in financing invoices issued to other businesses, not individuals.

How to Qualify for Invoice Financing? 

Qualifying for invoice financing usually requires businesses to have a track record of issuing invoices to creditworthy customers. Financing companies assess the creditworthiness of the invoices and the reliability of the customers. 

Other factors that may be considered include the business’s financial stability, the average size of the invoices, and the industry in which the business operates.

Applying for Invoice Financing

When you apply for invoice financing you can expect to be asked to provide:

  • The invoices you want to finance
  • Past bank statements
  • A copy of your driver’s license or other government-issued identification
  • A voided business check

FAQs about Invoice Financing

Invoice financing is typically structured in two main forms: factoring and discounting. Factoring involves selling the invoices outright to the financing company, who then takes over the collection process. 

Discounting, on the other hand, allows businesses to retain control over the collection process while using the invoices as collateral for the debt. The financing company advances a percentage of the invoice value upfront and charges interest.

Many industries can benefit from invoice financing, including manufacturing, construction, transportation, and wholesale trade. 

For example, a manufacturing company facing a cash flow gap can sell its outstanding invoices to a financing company to bridge the gap and continue operations. Similarly, a transportation company can use invoice financing to access immediate funds to cover fuel costs, maintenance, and driver wages.

Invoice financing can be an excellent solution for small businesses facing cash flow issues due to delayed customer payments. It provides immediate liquidity using outstanding invoices as collateral, thereby helping businesses manage expenses or seize growth opportunities. It’s typically faster and more accessible than traditional loans, with approvals usually granted within days. 

However, invoice financing can have higher interest rates and is primarily beneficial for B2B businesses. Businesses also need to consider that lenders typically finance between 80%-90% of the invoice value. Therefore, while beneficial, businesses should weigh the pros and cons based on their specific financial needs.