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Invoice Financing: Pros and Cons

Topics: Finance

Receiving a high volume of orders is a good problem to have, but as a result, you may experience headaches during payment collection. If you’re a large enterprise offering trade credit, then most of these headaches may seem necessary. Providing trade credit is crucial to winning and retaining customers. For example, around 50% of B2B sales are made on credit in the US. Unfortunately, late payments also affect nearly half of B2B sales, which has led businesses to turn to invoice financing.

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Invoice financing provides relief when your working capital gets tied up, preventing cash flow issues. Otherwise, businesses managing numerous orders often run into difficulties managing finances month after month. Especially if you have many small customers, you may be offering net 60 terms or more, where buyer payment is not due until 60 days after delivery of goods. 

We’ll take a look at what invoice financing means, its pros and cons, and whether invoice financing suits your business.

What is Invoice Financing?

Invoice financing is a working capital solution to borrow money immediately against unpaid customer invoices.

Also known as accounts receivable financing, invoice financing is similar to a collateralized loan or line of credit. Invoice financing companies advance as much as 80-90% of the value of uncollected invoices. In return, these lenders charge fees, which usually include a flat rate ranging from 1 to 5% of the invoice value, as well as interest on the total invoice. 

Accounts receivable teams are plagued by understaffing and inefficiencies from manual work, which leads to difficulties collecting payments. Invoice financing provides a stopgap for the resulting lag time between payment and delivery of goods or services.

Here’s an example of how invoice financing works:

  1. A trading company delivers goods to its customers and invoices them for $100,000 on net 60 terms.
  2. Since the customer has 60 days to pay, the company looks for invoice financing to bridge the gap in cash flow. The company shares the invoice with an invoice lender.
  3. The lender evaluates the creditworthiness of the invoice and provides an advance of 80% of the invoice, which is $80,000. The fee is 2% every 30 days. 
  4. The company continues to own and manage collecting on the invoice, meaning any associated costs are the company’s responsibility. 
  5. If the customer pays on time at the end of 60 days, the company pays back the cash advance of $80,000 minus a service fee of 3% of the invoice ($3,000). They also owe the lender $4,000 in interest ($100,000*2%*2 months). The company keeps the remaining $13,000.

The Pros of Invoice Financing

Companies using invoice financing can unlock the following benefits.

Expeditiously reduce DSO

Days sales outstanding, which measures the days it takes to convert sales on credit to cash, suffers when companies extend credit through offering net terms. A longer DSO can strain a company’s ability to stay afloat and maintain cash flow. 

However, if you set up invoice financing, the cash conversion cycle speeds up because you can receive fast advances on your account receivables. Using fully automated invoice financing from Apruve, your DSO further drops to one day.  

 Ease of application

Applying for invoice financing is often quick and easy, with minimal documentation needed. Unlike traditional lenders, invoice lending forgoes complex credit verification procedures. 

Since lenders focus on the payment history of customers and not the company itself, your company can still access financing even if it has no credit or bad credit. Access to credit starts a virtuous cycle where you extend credit and win customers. 

Invoice financing becomes even easier with fully automated, digitized solutions. While some of these platforms can be customized, Apruve is the only platform that combines trade credit programs with automated accounts receivables. 

The flexibility of invoice financing

With invoice financing, even though a third party offers financing, you still retain control over the receivables. You maintain visibility and ownership over receivables, choosing which invoices get financed and when. Businesses wary about a third party contacting their customers for payment may prefer invoice financing.

Depending on cash flow needs, you can resort to invoice financing to access emergency cash only when needed. However, a regular partnership with lenders enables you to continue extending net terms. 

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The Cons of Invoice Financing

Interest rates may be higher than traditional loan interest rates

Access to cash quickly comes with a price - invoice financing companies charge a fee and interest on the amount borrowed. 

Even if customers pay on time, you’ll still pay a percentage to the lender. You also lose some control over the process if you can’t pay off the advance until your customer pays you. If the payment is delayed, charges can add up quickly. Invoice financing fees rates often end up higher than traditional loans with a bank, and there are no guarantees as to when customers will eventually pay. 

Lenders may also ask for extraneous fees, late payment fees, or require monthly minimums on top of existing charges. Moreover, determining costs upfront can be difficult because final fees depend on when customers settle their accounts. 

Invoice financing providers don’t chase invoices

With invoice financing, the business continues to hold responsibility for collecting receivables due and chasing down overdue invoices. Even if customers default on payment, your company still needs to pay back lenders and incur additional fees if it takes longer than arranged.

Growing costs of receivables management and additional invoice financing fees could strain business finances further. 

Not all invoices can be financed

While invoice financing requires less documentation, lenders will only extend an advance against your creditworthy customers. Therefore, invoice financing is only possible against established businesses or those with a good payment record who are less likely to default. 

Companies with inadequate credit review procedures are less likely to qualify for invoice financing compared to those with robust credit procedures. 

Is invoice financing right for your business?

Invoice financing is a useful funding solution for B2B businesses, but whether it is the right strategy depends on your business. Invoice lending creates liquidity for operations when your working capital is tied up, leaving room for acquiring more customers. The downside is that the costs associated are usually higher than with traditional financing, and you still have the responsibility for collecting payment. Accessing invoice financing also requires tracking the invoices used as collateral, which can be burdensome and increase administrative costs. 

Automated invoice financing makes it easier for companies to keep and secure more clients. By connecting businesses with a network of lenders and automating payment collection, Apruve is reinventing the credit and accounts receivable process end-to-end. In streamlining each process and putting them on autopilot, companies use invoice financing to continue offering net terms while reducing DSO to one day. Best of all, with automated accounts receivables, you don’t have to manage your payment collections.   

Companies focused on expanding B2B business look beyond traditional invoice financing to the Apruve automation solution that unlocks efficiencies, solves cash flow issues, and generates more sales.

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Apruve enables large enterprises to automate long-tail credit and A/R so you can stop spending 80% of your time and resources on 20% of your revenue. We partner with each of our customers to solve their unique credit, payment, and accounts receivable challenges and build the right credit solutions for your markets, customers, and goals. 

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