What is Invoice Finance? The Pros and Cons of This Type of Financing

Joseph Williams
September 26, 2023
Fact checked by
Narayan

If you’re a small business owner, then you know that cash flow is key. You need to have money coming in to cover your expenses, and sometimes it can be tough to get by when your clients are slow to pay their invoices. That’s where invoice financing comes in. This type of financing can help you get the cash you need to keep your business running smoothly. In this blog post, we will discuss what is invoice financing, what are the types available, and the pros and cons of using it for your business. So, in order to learn more and find out if this option is right for you, keep on reading!

What is Invoice Finance and How Does It Work?

Invoice finance is a type of funding that allows businesses to borrow money against the value of their unpaid invoices. It’s a popular financing option for small businesses because it’s quick and easy to get started, and there are no long-term contracts or hidden fees.

When a business needs money to cover expenses but doesn’t have the time to wait for customers to pay their invoices, it can go through an invoice finance company to get a loan based on the value of those unpaid invoices. The company will advance a certain percentage of the total invoice amount, typically 70-85%, and then collect payment from the customer once the invoice is paid. This type of funding is ideal for businesses who need cash flow to cover expenses, but don’t want to take on more debt.

What are the Different Types of Invoice Finance Available?

Invoice finance comes in two general forms: factoring and discounting.

Factoring is where a business sells its invoices to a third party at a discounted rate in order to raise funds quickly. The funding company then pays the business the full value of the invoice, minus their fee, once the customer pays up.

Discounting works in a similar fashion, but instead of selling the invoice, the business takes out a loan using the invoice as collateral. Again, the funding company pays out the full value of the invoice less their lending fee once the customer has paid.

Both factoring and discounting can be useful for businesses that need to raise cash quickly and don’t have time to wait for their customers to pay.

Who Should Consider Using Invoice Finance?

Invoice finance can be a great option for businesses that need cash quickly to pay suppliers or cover other short-term expenses. It’s also a good choice for businesses with slow-paying customers, as the financing company will purchase the invoice and receive payment once the customer pays.

Before you decide if invoice finance is the right option for your business, it’s important to understand how it works. The financing company will review your current and past invoices, and then make an offer to purchase a specific percentage of them. Once you accept the offer, the financing company becomes responsible for collecting payment from your customers. This can be a great solution if you need cash quickly but don’t want to take on additional debt.

What are the Pros of Invoice Financing?

1. Increased cash flow – One of the primary benefits of invoice financing is that it provides businesses with quick and easy access to cash. This can help businesses cover expenses, expand their operations, and grow their businesses.

2. Relief from administrative burden – With invoice financing, the lender takes on the responsibility of collecting payments from customers. This can save business owners time and energy, which they can then devote to other tasks related to running their businesses.

3. Improved credit score – When a business takes out an invoice financing loan, it can help improve the business’s credit score. This, in turn, can make it easier for the business to get other types of financing in the future.

What are the Cons of Invoice Financing?

First, invoice financing can be expensive. Fees for invoice financing typically range from 1-4% of the value of the invoices being financed. This can add up quickly, particularly if you’re financing a lot of invoices.

Second, not all businesses will be approved for invoice financing. This is because the lender will want to make sure that you have a good credit history and that you’re likely to repay the loan. If your business doesn’t have a strong credit history or if it’s struggling financially, you may not be able to get approved for invoice financing.

Third, using invoice financing can limit your flexibility as a business owner. This is because you’ll be using your invoices as collateral for the loan. This means that if you can’t repay the loan, the lender could take possession of your invoices and you could end up losing money.