If you run a small business, you know that maintaining a consistent cash flow is crucial for running your business operations smoothly. Unfortunately, business owners often face a cash crunch due to delayed payments from clients. Once you have delivered your products and services ‘on credit’, your client may not process your invoices immediately. Depending upon your payment terms, you may have to wait 30 to 90 days to receive the amount.

But, what if, instead of waiting for your customers to pay up, you get the amount in advance from a lender? By approaching a lender with your unpaid invoices, you get paid faster for the products or services you have delivered. You can then focus on running your business and not worry about a hindrance in cash flow. This process is known as invoice financing. 

In this article, we will explore how does invoice financing work. We will also cover its benefits and limitations.

How does invoice financing work?

Suppose a business sells its goods and services to its customers on credit. So, most customers do not usually pay upfront but are instead charged at a later date. When the goods and services are delivered, the business generates an invoice payable within 30 to 90 days. 

Now, the business can approach a third-party financier for an invoice finance facility. This is how it works: 

  • Once the invoices are generated, they are forwarded to the third-party financier
  • The financier then reviews these invoices.
  • The financier then provides a percentage of the due amount as a loan to the business. This process is quick and typically completes within 24 hrs.
  • The business can then wait for the clients to pay off the outstanding amount on the invoices.
  • If unpaid, the business owners can pursue such payments themselves. Or they can get the financier to do it on their behalf.
  • Once the customer settles this invoice, businesses receive the remaining percentage of their invoice’s value, minus a small service fee charged by the financier.

Types of invoice financing

There are two types of invoice financing: invoice factoring and invoice discounting. Let us explore each one.

1. Invoice factoring

Invoice factoring is a process that heavily involves the lender who acts as the factoring provider. Your lender will keep an eye on your customers and see that they pay on time. They provide credit control services. Thus, you can save time and avoid running after late-paying customers.

If you opt for factoring, your customers will know you are using a factoring provider. Your lender can also credit check potential customers for you. This option is more accessible for smaller businesses to secure that do not have many resources or a long list of clients. 

2. Invoice discounting

If you opt for an invoice discounting facility, you are responsible for the credit control for any payment made to your account.

It is more straightforward than factoring but demands more active involvement from your side. Thus, it can be time-consuming. If you have an established business, you can approach a lender who offers an invoice discounting facility.

Advantages of invoice finance 

Some advantages of choosing invoice finance are: 

  • It gives your company quick access to cash: The most significant advantage of invoice financing is that you can arrange instant funds. As soon as the company issues an invoice, you can finance it and use the money for your business operations.
  • Quicker turnaround: Compared to other products like SME loans, both types of invoice financing have a rapid turnaround. Most financiers will pay you within 24 to 72 hours.   
  • No risk to assets: You can borrow money in place of your unpaid invoices and don’t have to risk your company’s assets.
  • Boosts credit sales: Invoice financing can help convert credit sales into cash almost instantly, which means your businesses can grow faster without worrying about restricted cash flow.

Limitations of invoice finance

  • The invoice finance facility is only available on commercial invoices meaning your customers have to be other businesses, not individuals.
  • If you choose to apply for factoring, you will involve the financier in your relationships with your clients. Your relationships may be potentially impacted by this. But, if you opt for the invoice discounting facility, you will have to spend time and resources chasing after late-paying customers.
  • While it is an effective short-term solution for better cash flow, its long-term costs can add up. For example, if your financier levies a hefty processing fee, it can add up to a substantial amount.

To sum up

Invoice financing allows businesses to mobilise the funds which would otherwise have been locked up in unpaid invoices. Thus, it is an excellent way to maintain short-term liquidity.

Are you worried about your business’s cash flow? Let Tata Capital help you. Whether you want to expand your venture, invest in new technology and machinery, hire a larger workforce, or take your business online, we’ve got you covered. Visit our website to learn more about our easy SME loans and other business finance options.

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