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How Do Invoice Financing Platforms Impact Vendors’ Cash Flows?

By Athena Rebello

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Updated on: Jul 11th, 2023

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10 min read

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Lack of enough cash flows to meet day-to-day operational needs is one of the major problems faced by small businesses in India. Most of them do not have a good credit history or a strong financial condition and therefore find it difficult to get bank loans. But is there an alternative?  The answer is Yes. Invoice financing is one of the best alternatives to traditional bank loans as it does not assess the company’s credit history. It provides companies with quick access to funds at a small fee. This helps businesses manage their cash flows better.

The increasing popularity of invoice financing amongst small businesses has led to an increase in the number of invoice financing platforms. But before we move ahead and understand how these platforms work, let us understand what invoice financing is. 

What is invoice financing?

Invoice financing is a financial service in which businesses can get upfront payment against their pending accounts receivables. In other words, the company sells its accounts receivables to a third-party and gets advance payment for the same. In most cases, businesses receive the payment (usually ~85%) of the invoice value immediately. After receiving payment from the customers, the business owner pays back the lender. The fee for the service typically ranges from 1% to 3%. 

How does invoice financing help businesses with their working capital needs

Invoice financing impacts working capital by providing short-term financing secured by outstanding invoices. It helps improve working capital by selling a business’s unpaid accounts receivables to a third party. 

This third party pays the value of the invoices for a small fee. This helps businesses get immediate cash to improve cash flow, allowing them to pay company expenses. 

It is a form of working capital management, and its processes vary depending on the financier you choose. 

Benefits of invoice financing on working capital

Since invoice financing is quite a cost-effective option for companies, here’s how a company can leverage invoice financing to get immediate working capital: 

  • Using their unpaid invoices as collateral for financing working capital, the company can receive funds such as paying the staff or buying new machinery. 
  • Instead of waiting for customers to pay, which can take a long time, the company gets cash in advance from the lenders based on invoice value. 
  • It can also lower the risk of bad debts and delayed payments since, in the case of invoice factoring, the lender assumes the responsibility of collecting the payment.
  • Some companies, like small and medium enterprises, may not be not eligible for loans. Such companies can use invoice financing to get immediate capital and meet liquidity needs.
  • Since businesses do not need to pledge collateral, their other assets are not blocked, leaving them for other uses — and to even get another loan on those assets, which can further improve working capital. 
  • Invoice financiers do not place specific conditions on how the cash is to be used, unlike traditional lenders, allowing businesses the freedom to finance working capital in whichever department needs it the most. 

As for collecting the value of invoices from the customers, either the business or the lender can do that. If the lender collects customer payments, the process is called invoice factoring. And if the company collects customer payments, the process is called invoice discounting

How do invoice financing platforms work?

Invoice financing platforms act as a bridge between the business and the invoice financing company. These platforms provide easy access to entities that purchase invoices. In simple terms, it is an online marketplace that connects businesses with finance providers that offer invoice financing services. 

Here's how an invoice financing platform typically works:

1. Business registration: A business first registers with the platform and provides information about the invoices they want to get financed for, such as the amount, due date, and customer details.

2. Invoice verification: The platform verifies the authenticity and validity of the invoices to ensure they are genuine and eligible for financing.

3. Funding offer: The platform presents the verified invoices to a network of finance providers who make funding offers to the business. The offers may vary in terms of the amount of funding offered, the interest rate charged, and the repayment terms.

4. Acceptance: The business reviews the funding offers and selects the one that best meets its needs. They accept the offer, and the finance provider provides an immediate cash advance to the business.

5. Collection and repayment: The finance provider collects the full amount of the invoice from the customer on the due date. They deduct their fees and interest charges and remit the remaining balance to the business. The business repays the finance provider the advanced amount plus the fees and interest charges.

Impact of invoice financing on cash flows 

Cash flow crises are perhaps the most common problem faced by small businesses. Invoice financing comes in handy in such situations. It helps solve the cash flow problem without disturbing the company’s total debt. Here are some ways in which invoice financing impacts cash flows:

Improved cash flow: Most small and medium enterprises do not have the required credentials to be eligible for formal credit. Invoice financing makes it very easy for businesses to manage their need for liquidity. The invoice financing platforms further improve the process by connecting MSMEs with finance providers. 

Reduces risk of default: It helps businesses generate enough working capital by getting invoice payments in advance, which helps reduce the risk of default. 

Cost-effective option: Invoice financing is a cost-effective option for companies to raise short-term funds as compared to traditional bank loans. 

No need for collateral: Most financing companies do not ask the business to provide any collateral against the invoices. The invoice itself acts as collateral and helps small businesses raise funds without the risk of losing their high-end assets. 

No restriction on usage: Unlike traditional loans, the funds raised through invoice discounting do not have any restriction on usage. In other words, the business can use the funds raised for any purpose without any restriction. 

Who can use invoice financing as an option for working capital management? 

Invoice financing can be a useful tool for the following types of businesses: 

  • Ones that need access to capital quickly and efficiently, especially if they face difficulty obtaining other types of credit. 
  • Industries that regularly invoice other businesses and, therefore, have long billing cycles — such as retail, manufacturing, wholesale industries and distributors. 
  • Exporters who are involved in slow payment cycles.
  • Businesses that make seasonal sales and have slow-paying customers.

How can a business manage their working capital with invoice financing as a strategy?

A company can manage its working capital with invoice financing as a strategy by using its unpaid invoices as collateral for financing. It can help them raise funds against unpaid invoices and help secure attractive repayment terms. 

Plus, invoice financing to finance working capital is flexible. This means that invoice finance can align with the business's changing needs and market. It can also accommodate seasonal demand and supply fluctuations impacting the business’s cash flow and working capital needs. 

It can be a go-to strategy for businesses that do not qualify for high-interest loans or are not keen to pay for them and face cash shortages to pay for even short-term expenses. 

 

About the Author

A Chartered Accountant by profession and a writer by passion, my expertise extends to creating insightful content on topics such as GST, accounts payable, and invoice discounting.. Read more

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