All you need to know about Invoice Financing

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What is Invoice Financing?

In short – invoice financing is just another form of borrowing, allowing businesses to improve their cash flow by unlocking cash tied up in unpaid invoices. This allows businesses to cover their costs and expenses in a timely manner and reinvest the leftover funds back into the business within a shorter time period, facilitating faster growth than would otherwise be possible if the company had to wait for their invoices to be paid in full. This means their working capital is used more efficiently.

Invoice Financing is short term in its nature, due to the fact that it is based on the payment terms prescribed in the underlying invoices. The duration of the loans issued as part of Invoice Financing therefore usually ranges between 30 to 90 days with few exceptions on either side of the spectre. This may be because shorter payment terms make it difficult for lenders to verify the invoices in time to release the funding, while longer payment terms may make other types of borrowing more appealing to the borrower due to the lower financing costs, even if this usually means increased load of paperwork and additional guarantees demanded from the borrower.

For the lenders, Invoice Financing is an appealing choice of financing because of three main factors. Firstly, in Invoice Financing the lender can see and to a large extent verify the expected cash flow of the borrower, while retaining the guarantee that the borrower will cover the invoices using their own funds, in case the customer defaults on the payment of any specific invoice. Secondly, because of the short-term nature of this type of lending, lenders can demand higher interest rates on the loans – usually ranging between 1% and 4% per month. And third, but not least, these loans can be viewed as more secure – the time span is too short for the financial position of the borrower to change too much from the moment that the loan is given out to the time when it is due to be repaid. If due diligence is carried out properly on the borrower’s financial position, the risk of default is minor.

How does Invoice Financing Work?

Imagine a company has 1000 euros in working capital at the beginning of the month, which they use to buy products, which take 15 days to deliver and they settle the bill upon delivery. Then they sell these products to their customers for 1200 euros (at 20% mark-up) and agree on 30-day payment terms. Without using Invoice Financing, at the end of this 30-day period they will have made a gross profit of 200 euros from these 1000 euros in working capital.

Now let’s imagine that instead of waiting for 30 days to get paid, this company uses Invoice Financing to get cash for these invoices straight away. Invoice Financing companies often release between 80% to 90% of the outstanding invoice value. In this example, for ease of calculation, we will presume they release 1000 euros of the invoice value. Once the money is released, the company can buy products from their suppliers again and sell these at a 20% mark-up again. As we presumed 15-day delivery times, this would allow the company to fit in 2 orders from their suppliers and two sales to their customers within these 30 days instead of just one, meaning their turnover and gross profit would be double at 2400 euros and 400 euros respectively.

The company will, of course, need to pay interest for the cash released to them by the Invoice Financing provider, but with this ranging between 1% and 4% per month, even at the higher end this spectre, it would deduct only 60 euros from their gross profit for the period (1000 euros at 4% for 30 days and 1000 euros at 4% for 15 days). With all other things being equal (meaning, the company does not need to, for example, employ extra staff to facilitate the increased turnover), it makes sense for the company to use Invoice Financing in order to make higher revenues, profits, and facilitate the overall company growth.

Why do firms use Invoice Financing?

While there is very little leeway to pay the regular company bills late, as workers expect to receive their wages weekly or monthly and rent is often demanded in the form of prepayment, in order to secure good customers, companies are often pushed to offer delayed payment terms for the products and services they provide. These often range anywhere between 15 and 120 days in duration.

As it is virtually impossible to find an employee willing to wait for their wages for 120 days in arrears for the simple reason that they have their own bills to pay and mouths to feed, firms are often relying on some form of financing to bridge the gap between the incoming and outgoing cash flows. The added cost of financing is incorporated in the cost of the products and services, so, if a customer demands delayed payment terms, they bear the cost of it through higher prices.

Even those companies that have a steady cash flow and may afford to wait for the delayed payments from customers, often choose to use Invoice Financing, as this allows them to achieve shorter working capital turnover cycles, meaning that they can grow their businesses at a faster pace, as we saw in the example used in the above section, explaining, how Invoice Financing works.

The pros and cons of Invoice Financing

The pros:

  • Easy and fast access to financing, if compared with other types of financing available on the market;
  • No need to put down personal or real estate collateral in order to receive funding – invoices issued to customers work as security;
  • Flexibility regarding funding size – limits can be increased or decreased in line with the business growth as and when needed;
  • Accessible to star-ups and growing businesses with expanding sales, but little or no history proving the eligibility for bank funding;
  • Allows a company to scrap discounts for early payments from customers and increase their profit margins in such a way;
  • Allows the company to demand discounts from suppliers for volume-buying or early payment, again boosting profit margins;
  • Gives a competitive advantage against competitors, as Invoice Financing allows offering favorable payment terms to customers;
  • It allows faster growth of a company by freeing up working capital.

The cons:

  • The cost of Invoice Financing is higher than for other types of financial funding;
  • The responsibility of unpaid invoices remains the company’s liability;
  • The necessity to share the whole financial situation of the company with the Invoice Financing Provider;
  • Success or failure to secure Invoice Financing very much depends on the financial position and reliability of the company’s customers.

Invoice Financing vs Invoice Factoring – do not get confused! 

While very similar in nature, invoice factoring differs from invoice financing by the fact that it requires the company to give up control of collecting debts from the customers. When using Invoice Financing, the company remains in control of its debtors and customer relations regarding debt collection.

Because of this crucial difference, invoice factoring is often more expensive, as the invoice factoring provider will bear the risk and the cost of unpaid invoices and will need to have the resources to carry out debt collection services. This is not to say that companies do not choose invoice factoring over invoice financing. The cost of debt collection by themselves may be higher than the small percentage fee commanded by the invoice factoring service providers.

Why TFGcrowd started Invoice Financing and how do we stand out among the competition?

TFGcrowd is always striving to provide easy and transparent financing solutions for businesses looking to finance their projects outside the mainstream banking industry. Our no-nonsense approach to everything that we do has now been implemented into invoice financing, meaning no hidden fees, no long-term binding agreements and flexibility for the clients to pick and choose the exact invoices they wish to finance, complemented with outstanding customer service and discretionary approach towards the payers of the invoices, is what makes us stand out amongst the competition offering invoice financing services.

For the investors choosing to invest through our platform in Invoice Financing investments, this will be another great chance to earn high returns, this time without locking their investments in for longer periods of time. In the coming months, we will be working hard on expanding the range of invoice financing investments available to choose from on TFGcrowd, improving your investing experience every step of the way.