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What is Invoice Financing: Process, Examples and FAQs

By Annapoorna

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Updated on: Aug 28th, 2023

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8 min read

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Invoice financing is a method of raising short-term finance by leveraging your unpaid sales invoices. Rather than waiting for weeks to get paid, one can raise funds immediately and focus on running business smoothly. Invoice financing will unblock cash tied up in the accounts receivables of the company. Further, invoice financing can be a collective term for other kinds of invoice-based lending extended in the market.

Meaning of invoice financing

Invoice financing means raising funds by leveraging outstanding invoices. It is thus referred to as ‘receivable financing’. It facilitates self-generation of cash flows to meet operational expenses such as salary, wages, etc.
 The lender can be a bank or any other financial institution that provides loans against outstanding accounts receivables. The two types of invoice financing are:

  1. Invoice factoring: In this type of financing, the outstanding invoices are sold to the financing company. Here, the financial institution has complete control over the submitted invoices and at the same time, it is responsible for the invoice collection process.
  2. Invoice discounting: In this type of financing, the lending company does not have any control over the submitted invoices. The business itself is responsible for the invoice collection process in invoice discounting.

Both these methods have their own benefits and disadvantages. Choosing the best one would depend on one’s business needs.
 

Parties involved in invoice financing and eligibility

Parties involved in invoice financing are:

  • Supplier: The supplier is the person who sells goods to the buyer on credit. To meet their short-term requirements, the supplier raises funds against outstanding sales invoices by selling the same to the lending institute.
  • Buyer: The buyer can make use of the credit period instead of making immediate payments to its vendors. On maturity, the buyer can either make payment to the financial institution or the supplier as per the agreed terms.
  • Financial Institution: The financial institution provides short-term advances by keeping unpaid sales invoices as collateral. It charges a financing fee for providing such a service.

Pros and cons of invoice financing

Some of the benefits of invoice financing are:

  • Fast cash: Unpaid invoices keep huge funds tied up. By using invoice financing, one can avail of funds within +/- 72 hours of applying. Businesses generating high-value invoices are highly benefitted.
  • No collaterals required: Funds are raised by leveraging unpaid sales invoices. No assets of the company need to be kept as collateral.
  • Improved credit sales: Invoice discounting converts credit sales into cash. Thereby, helping SMEs in quick growth and development.
  • Better survival: Greater cash flow gives your business a boost. Many businesses fail due to poor cash flow. Invoice financing improves cash flow and thereby helps your business to meet its overhead expenses. 

Some of the drawbacks of invoice financing are:

  • Expensive at times: The fees payable for invoice financing may look competitive with rates ranging from 1-5% of the cumulative invoice value in the month. However, the Annual Percentage Rate (APR) could be as much as 79%.
  • Dependency on customer invoice payments: The fees charged depends on the time taken by the customer to pay the invoice. There could be additional fees charged where the invoice payment gets delayed beyond the due date. Moreover, there are higher risks where customer doesn’t make payments altogether.
  • Not for B2C business models: Invoice financing is not for businesses selling directly to consumers since there are low chances of credit sales on the sale of goods and services.

How does invoice financing work?
 

How does invoice financing work

Step 1: A business sells goods to the buyer and issues an invoice with a window of +/- 90 days for payment.

Step 2: The seller decides to sell the unpaid invoice to the lending institute. 

Step 3: The financial institution accepts the transaction, buys the invoice and issues a certain percentage of the invoice as an advance to the seller. The invoice collection procedure may be carried out either by the seller or the financial institution depending upon the agreed terms.

Step 4: When the buyer makes the final payment, the balance invoice amount is remitted to the seller after charging its service fee.

Invoice financing process in detail

Your invoices serve as collateral under invoice financing. The lending institution will advance a certain percentage of unpaid sales invoices. You will receive the remaining amount minus the financing charges when the customer repays on maturity.

Let’s understand the invoice financing process in detail:

  • Credit sale: A supplier makes a credit sale to its customer with a payment window of 45-90 days. To meet its working capital requirements, the supplier decides to sell the unpaid invoices to the lending institute.
  • Receive funding: The lending company will advance funds as a percentage of the outstanding invoices. It will charge a fee for providing such finance. The supplier (borrower) will receive short-term funds to meet its cash requirements. 
  • Payment collection: On maturity, the business will collect the payment from its customers and repay the advance to the lending company along with the financing fee. It will depend on the type of financing agreement entered into and whether the lending institute will get involved in the payment collection process or not.

Examples of invoice financing

Example: A supplier issues an Rs.10,000 invoice of Rs.10,000 to its customer with a 60 days credit period. Here, the invoice amount is blocked for the supplier for 60 days which slows the cash flow. So, the supplier can get into an agreement with the invoice financing company to raise funds. The lender issues funds at a certain percentage of the invoice amount, say 80%. 

The supplier will pay an amount, say Rs. 8,000, upfront without waiting for a 60-day maturity period. At invoice maturity, the lender will pay the balance invoice amount (Rs. 2,000) to the supplier after deducting its service fee. 

What is invoice financing costs?

There is a standard charge levied for availing the invoice financing option. It is also termed as discount rate. The average discount rate in India ranges between 1-1.5% of the cumulative invoice value factored on a per-month basis. For more information, read our article on Invoice Financing Cost.

Conclusion

For invoice financing, lenders consider the customer’s payment history when evaluating the application. So, even small businesses or startups can qualify for invoice financing. Furthermore, it requires minimal documentation; sometimes, you get funding within 24 hours. It is thus advantageous when you are facing a cash crunch. It is recommended for businesses which require quick cash inflow.

There are a wide variety of invoice financing options available in the market. One can decide the best one as per its business needs and requirements. 

FAQs on Invoice Financing

What is invoice financing in India?

Invoice financing in India can be defined as a process via which sellers can get advances against invoicesdue from their buyers. Accordingly, businesses pay some percentage of this cumulative invoice value as a fee to their lender.

What are the uses of invoice financing?

Some uses of invoice financing include fast cash, highly valuable at times of emergency, and an attractive option for companies with insufficient credit ratings to secure funds.

Do banks do invoice financing?

Yes, invoice financing can be extended by the bank.

Is invoice financing a good option for my business?

Invoice financing is crucial since it offers fast funding for businesses that qualify. Businesses having higher credit sales with low bad debts can go for this option for short term funding.

How does invoice financing affect customer relationships?

invoice financing in reality promotes success for businesses allowing them to maintain a steady cash flow in the event of long invoice payment terms. 

Can invoice financing help with late-paying customers?

Yes, invoice financing helps businesses with late-paying customers.

How do you use an invoice for financing?

Businesses can pay some percentage of the invoice value to the lender as a fee for borrowing the money before the due date of invoice.

How much does invoice financing cost?
Invoice financing costs about 1% to 1.5% of the cumulative invoice value factored on monthly basis.

About the Author

I preach the words, “Learning never exhausts the mind.” An aspiring CA and a passionate content writer having 4+ years of hands-on experience in deciphering jargon in Indian GST, Income Tax, off late also into the much larger Indian finance ecosystem, I love curating content in various forms to the interest of tax professionals, and enterprises, both big and small. While not writing, you can catch me singing Shāstriya Sangeetha and tuning my violin ;). Read more

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