Invoice Financing Pros and Cons
Invoice financing (or accounts receivable financing) has a lot going for it in the right situation, but there are also drawbacks you should consider.
- Fast approval, minimal paperwork
- Helps mitigate cash flow emergencies
- Often credit flexible
- Relatively high rates/cost
- Need invoices as proof/collateral
- Generally doesn’t work for B2C businesses
Pros of Invoice Financing for Small Businesses
If you’re looking for a fast way to get a short-term type of financing, invoice finance solutions could be a solid option. Because the invoices themselves serve as your collateral, you won’t need to put up other assets to borrow money.
The application and approval process is much faster than with traditional loans, and you can see funds deposited in your account in as little as one business day. And the fees, while higher, are clearly identified up front so you know the cost of borrowing money.
Cons of Invoice Financing for Small Businesses
The biggest drawback to invoice finance solutions is the high cost. While quick approvals can help you solve immediate financial woes, you will pay for that convenience.
The fact that your collateral is your invoice may mean some types of businesses immediately won’t qualify. B2C (business to consumer) companies looking for financial help may be out of luck, especially if their cash flow originates at a point-of-sale machine rather than long-term invoices. As well, the invoice discounting rate you’d receive for your invoices means that you’re essentially losing out on the full revenues of the invoice that would have been realized over time.
What is Invoice Financing?
Invoice financing, also called receivables financing or invoice trading, is a form of an asset-based loan that allows businesses to borrow money against outstanding invoices from customers. In return for fast access to cash, a business pays an invoice finance company a fee, sometimes a percentage of the amount borrowed.
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Types of Receivable Financing
- Invoice Factoring: common for small businesses in industries like clothing or manufacturing, where long accounts receivable are part of the normal business cycle. Factoring typically means the invoice factoring company purchases the invoice at a discount . That company is now in charge of collecting payment on the invoices. You typically receive 50-80% of the invoice value up front (also known as invoice discounting) based on the risk profile of your clients. This invoice factoring fee can be structured in any number of ways, but it generally nets out to be about 3-5% of the invoice value.
- Invoice Financing Services: like factoring except that this isn’t a sale of your accounts receivable. Invoice finance works by using accounts receivables as collateral to get an advance, but you are ultimately responsible for collecting payments. If your customer payments become delinquent, you will be responsible for the amount you were advanced. The fees are usually 2-4% of your invoice value per month.
- Receivable-Based Line of Credit: a credit line based on a percentage (usually of 80-85%) of value of your outstanding receivables. The value is calculated based on the aging of the invoices. You will pay a pre-negotiated interest rate based on your balance. When an invoice gets paid, your balance will be reduced. There’s usually a fee when you draw the credit line, but this is usually a cheaper option than invoice factoring or invoice financing with APRs often less than 20%.
Tip: Use Nav’s free invoice financing calculator to translate the cost of invoice financing to an Annual Percentage Rate (APR) so you can compare the cost to other financing options.
Recourse Factoring: A Quick Lesson
You may have noticed something interesting above: with invoice financing, it’s you who is ultimately responsible for getting your clients to pay outstanding invoices.
With invoice factoring, the invoice factoring company takes on those invoices and is responsible for collecting payment. If your client never pays, the lender takes that risk. That’s why invoice factoring tends to charge higher fees. There’s more risk for the company of not getting paid.
It’s important to understand the difference between recourse and non-recourse factoring or financing. Recourse factoring means the business is ultimately responsible if the invoice is not paid. Non-recourse financing means the factoring or financing company is out of luck if the invoice isn’t paid. Note that invoice financing or factoring is not a substitute for debt collection.
Invoice Financing Offers
Looking for an invoice financing or invoice factoring company? Here are our recommendations.
Requirements to Qualify for Invoice Factoring or Financing
Because of the heavy focus on the invoices themselves, almost any B2B business can qualify for invoice financing— provided the company responsible for the invoice is a good credit risk. If the invoices themselves make sense for the invoice financing company to lend against, they most likely will. In other words: if a given client has a history of paying on time and has a good reputation, it’s likely a good risk for a financing company to take on.
The amount financed or factored will depend on the quality of the invoices and credit history, which in some cases refers to the borrower’s credit, and in other cases refers to the credit of the company that must pay the invoice.
Be sure to consider all your options to determine if it makes sense to finance your invoices, as it may be more than you’re willing to pay over time. You do have other financing options, including working capital loans and business credit cards.
Best Candidates for Invoice Financing:
- B2B Businesses
- Seasonal Businesses
- B2B businesses with well-respected clients
- Businesses in industries with long billing cycles — e.g. clothing, retail, manufacturing, etc.
- Businesses with large invoices and purchase orders
Industries Best-Suited for Invoice Factoring or Financing Include:
- Real estate
- Healthcare services and medical suppliers
- Marketing services
- Business consulting and legal services
Invoice factoring or financing is not a great fit for B2C companies or subscription-based revenue companies.
How Do You Apply for Invoice Financing?
Compared to many small business financing options, the application process for invoice financing, invoice funding, or invoice loans for small businesses is a pretty quick and straightforward way to get cash for your business. If your chosen invoice finance provider or financing company has an online application, even better.
Like with small business loans, the financing company will have various requirements for your application, but the unpaid invoices will be the most important component. Some may look at your personal credit and/or business credit, or business financials. It’s best to ask before you begin the process to know where you may have the best chance for approval. Some companies may work with small businesses that have bad credit, while others may be a better fit for younger startups or those with lower annual revenue, so it’s worth your time to investigate.
Nav’s verdict: Invoice Financing
The overall APR, typically 15-35%, is high compared to that of banks or online term lenders. But it’s a good short-term solution, when most of your short-term assets are tied to accounts receivable, that lets you avoid the lengthy bank loan application for a short-term loan, SBA loan, or other ways you may seek out to get some much-needed cash. It’s also much better compared to expensive merchant cash advances. Your credit score also doesn’t matter as much. Your clients’ credit scores will also be taken into account. Therefore, it’s a good solution if you have receivables but haven’t built up your credit history enough to get a credit line from a bank.
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