Managing cash flow can be one of the most challenging aspects of running a business. Late payments and long payment terms often strain working capital, making it difficult to meet operational expenses or seize growth opportunities. This is where invoice finance comes in as a practical solution. But what is invoice finance, and how does it work? In this guide, we’ll break it down for you step by step.
What is Invoice Financing?
Invoice financing is a type of business financing that uses outstanding customer invoices as collateral to secure a loan or line of credit. It helps small-business owners account for gaps in cash flow to purchase inventory, pay employees, and grow their business.
Invoice financing can be structured as a loan or line of credit, and is often easier to qualify for than other small-business loans. Also known as accounts receivable financing, invoice financing allows businesses to borrow against their outstanding invoices.
Here’s a simple step-by-step explanation of how invoice finance works:
Step 1: Issuing an Invoice
Once you deliver goods or services to your customer, you issue an invoice as usual. The invoice specifies the amount due and the payment terms.
Step 2: Submitting the Invoice to the Finance Provider
You choose to submit the unpaid invoice to an invoice finance company. Depending on the provider, you might upload it to an online platform or send it directly to their team.
Step 3: Receiving an Advance
The finance provider assesses the invoice and advances a percentage of its value—usually between 70% and 90% of the total. The advance is transferred to your bank account within 24 to 48 hours, giving you immediate access to cash.
Step 4: Customer Payment
When your customer pays the invoice (either to you or the provider, depending on the arrangement), the remaining balance is released to you. The provider deducts their fees from the final payout.
What are the Usual Fees?
When considering invoice financing, understanding the usual fees is crucial to make an informed decision. Invoice financing companies typically charge a combination of fees, including a service fee and an interest rate based on the value of the invoices being financed.
These invoice financing costs can vary depending on factors such as the creditworthiness of your customers, the volume of invoices financed, and the type of facility chosen. Despite the fees, the ability to unlock cash flow quickly often makes invoice financing a cost-effective solution for businesses looking to bridge cash flow gaps or fuel growth opportunities.
Types of Invoice Financing
Selective Invoice Finance
A flexible financing solution where businesses choose specific invoices to sell to a finance provider in exchange for immediate cash.
How It Works:
Businesses upload individual invoices to a platform.
The finance provider advances a percentage of the invoice value (typically 70%-90%) upfront.
An invoice financing company provides quick access to cash by advancing payments on selected invoices.
The remaining balance, minus fees, is paid once the customer settles the invoice.
Ideal For:
Businesses with occasional cash flow needs.
Companies that want the flexibility to finance only certain invoices rather than all receivables.
Benefits:
No obligation to commit to all invoices.
Quick access to funds without a long-term contract.
Contract Finance
A funding solution tailored for businesses with ongoing or long-term contracts, such as subscriptions, service providers, construction companies, or contractors.
How It Works:
Financing is based on the value of agreed milestones, subscription duration, or work completed in a contract.
Funds are released as work is completed and invoices are issued, ensuring steady cash flow throughout the contract.
Receivables financing can be used to access immediate capital by leveraging unpaid invoices, differentiating it from other options like invoice financing and factoring.
Ideal For:
Businesses with large, long-term projects that have staggered payments.
Companies that need working capital to cover upfront costs like materials or wages.
Benefits:
Stabilises cash flow during extended projects.
Provides confidence to take on bigger contracts without cash flow constraints.
Whole Ledger Finance
A comprehensive solution where a business’s entire accounts receivable ledger is financed, rather than selecting specific invoices.
How It Works:
The business provides access to its full debtor ledger.
The finance provider advances a percentage of the combined value of all outstanding invoices.
As payments are received from customers, the facility is adjusted accordingly.
Ideal For:
Companies with a high volume of invoices seeking a streamlined cash flow solution.
Businesses looking for an ongoing relationship with predictable funding levels.
Benefits:
Provides maximum cash flow support by leveraging all receivables.
Simplifies funding by automating the process for all invoices.
Comparison Summary:
Feature
Flexibility
Best For
Funding Speed
Control Over Invoices
Selective Invoice Finance
High (choose specific invoices)
Occasional cash flow needs
Quick
Retained
Contract Finance
Medium (linked to contracts)
Long-term contracts/projects
Moderate (based on milestones)
Depends on contract terms
Whole Ledger Finance
Low (all invoices included)
Ongoing high-volume receivables
Quick, with automated processes
Minimal, as all are included
Invoice Financing Example
Let’s consider a practical example:
A business has an outstanding invoice for $10,000 and needs to access cash quickly to pay its employees.
The business applies for invoice financing and is approved for a cash advance of $9,000, which is 90% of the invoice value.
Your customer pays the full $10,000 on day 60.
Invoice financing lender deducts their fees and transfers the remaining balance to you.
Benefits and Drawbacks of Invoice Financing
Invoice financing offers several advantages for businesses looking to improve their cash flow. Here are some key benefits:
Immediate Cash Flow: Invoice financing provides quick access to funds, helping businesses meet their financial obligations without waiting for customers to pay.
Reduced Administrative Burden: By outsourcing the collection of payments, businesses can focus on core activities rather than chasing unpaid invoices.
Control Over Customer Relationships: Unlike invoice factoring, invoice discounting allows businesses to maintain control over their customer interactions.
Flexibility: Businesses can choose which invoices to finance, providing a tailored solution to their cash flow needs.
Improved Cash Flow and Reduced Credit Risk: By converting unpaid invoices into immediate cash, businesses can stabilise their cash flow and reduce the risk of bad debts.
However, there are also some drawbacks to consider:
Risk of Default: If a customer fails to pay an invoice, the business may still be responsible for repaying the lender.
Loss of Control in Factoring: With invoice factoring, businesses may lose control over customer relationships, which can impact their reputation.
Administrative Burden in Discounting: In invoice discounting, businesses still need to manage the collection of payments, which can be time-consuming.
Reputation Risk: If the lender or factor is not professional in their collection efforts, it can damage the business’s reputation.
Invoice finance is a powerful tool for businesses looking to manage cash flow effectively and reduce the stress of waiting for payments. By understanding how it works, you can make an informed decision and leverage this solution to keep your operations running smoothly.
If you’re considering invoice finance, InvoiceInterchange offers flexible and fast solutions tailored to your needs. Contact us today to learn how we can help your business thrive.
