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Invoice financing is a form of business financing that could save you from having to take a loan from your distant Uncle or that bank you hate.
If you issue invoices and you struggle with cash flow, this is for you.
What is invoice financing?
Invoice financing is a way for businesses to borrow money against the amounts due from clients. Invoice financing helps businesses improve cash flow, pay employees and suppliers, and reinvest in operations and growth earlier than they could if they had to wait until their customers paid their balances in full.
The benefit is that you get paid sooner, giving you working capital to pay your bills, edge inflation, and run your business.
The disadvantage is that it reduces how much you get paid by your client. This is also called “receivable financing” since you’re trading your accounts receivable for cash.
How does invoice financing work?
For an invoice to qualify for financing, it must have a payment term of 30 to 90 days. Generally, with banks, it takes three to seven days to qualify for invoice factoring, however, with Bridger, we finance in 4-24hours.
The financing company will check out the creditworthiness of your clients, too—they want to make sure they’re not dealing with people who won’t pay their invoices.
Here’s a super simple example. Let’s say you run a food supply business. You’ve just sent your client Turkey Republic an invoice for $20,000, payable in 45 days.
Problem is, you need cash ASAP to buy new ingredients for supply. So you factor Turkey republic’s invoice. The factoring company gives you $20,000, minus a small percent for their rates. Now, you have the cash in hand. And once Turkey republic pays his invoice, the financing company will have their money as well.
How it differs from other financing options
Invoice financing/Factoring is not a loan, because there isn’t anything to pay back. The responsibility is on the financing company to collect the receivables and get paid.
And unlike a line of credit, this is a one-time cash infusion, directly related to the particular invoice you want to finance, while a credit line is an ongoing source of capital you can draw from when needed.
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Invoice financing rates
When you finance invoices, you can expect to receive about 80% of the value of your accounts receivable upfront. You’ll get the other 20%—minus the factor rate—once the client pays their invoice.
The factor rate (also called a discount rate) is a percentage of the invoice value, charged weekly or monthly. The industry standard is 0.5–5% per month.
A lot of factors have a tiered system. The longer your client takes to pay an invoice, the higher the factor rate.
Here’s a step-by-step example using Greg. This example doesn’t use a tiered system and doesn’t take into account additional fees (discussed below).
- You invoice Greg for $2,000, term 30.
- You factor the invoice with Bridger at a rate of 3.5% monthly.
- Right away, Bridger sends you $1,600. (That’s 80% of $2,000.)
- After 30 days, Greg pays the invoice.
- Bridger sends you $330, the rest of the money they owe you. (That’s $400, minus 3.5% monthly for one month.)
Other invoice financing fees
Before you sign up for financing, find out whether these charges exists:
- Account opening fee. When you start a relationship with a financing company, a fee is often charge to open an account. This is Free on Bridger.
- Renewal fee. If you have a contract with a financing company, they may charge you each year to renew your account. Free on Bridger.
- Collection or overdue fees. If the factor is forced to collect money from a client who is late, they may charge you a penalty. They may even charge you a flat fee for all late payments, whether they need to go through collections or not.
Choosing an invoice financier.
When it comes time to choose an invoice factor, consider what is most important to you. For instance, what's the level of relationship that financing will have with the buyer? Before signing any formal agreements with the factor, be prepared to ask the following:
- How will the factor communicate with your clients? Will they call them to remind them of upcoming payments? Or will they take a subtler approach? If you’ve worked hard to build up person-to-person relationships with your clients, consider how working with a financiers may affect those relationships, and how these can be managed.
- How long will it take to get funding? What’s the typical turnaround time for a financing from when your documents have been submitted?
- Are you looking for non-recourse or recourse funding? You’ll be taking into account a different factor rate for each.
- What’s the advance rate? While 80% upfront is an average, the actual rate may vary from factor to factor. It could be as low as 50%, or as high as 95%.
- What do they need so you can get started? Unlike a bank, most factors aren’t interested in your company’s financial reports. But what info do they need before you start factoring? They may be looking at your credit history or the credit ratings of your clients. That could slow down the process of getting funded.
- Are they familiar with your industry? It’s best to work with a factor that understands your industry and works with other businesses in it. Plus, some factors only work with certain industries.
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Invoice factoring vs. invoice financing
Sometimes the terms invoice factoring and invoice financing are used interchangeably. However, they’re two slighly different financial services.
With invoice factoring, a factor buys your receivable (the money people owe your business), assuming a certain amount of responsibility for them. They take on the responsibility of collection from your clients.
With invoice financing, you still own your accounts receivable. The invoice financing company just looks at it, calculates how much you’re expecting to get paid and when, and gives you a cash advance against that amount—typically around 80% of the total invoice amount, and the rest when the customer pays you (minus a percentage for their fee, of course).
Factoring generally costs less for you (the small business owner) but requires you to hand over control of your accounts receivable to another company. Financing, on the other hand, lets you hold onto your accounts receivable but costs more.
Recourse factoring vs. non-recourse factoring
Let’s go back to the Greg example. Say you factor that $20,000 invoice, but once it’s time to pay, Greg stops picking up his phone or answering his email. The factor you sold Greg’s debt to can’t collect the money.
Now what? That will depend on what kind of factoring you’re using—recourse factoring, or non-recourse.
Recourse factoring
With recourse factoring, even after you’ve sold an invoice, you’re still liable for whether it gets paid or not. If the factor can’t collect on an invoice, you have to pay them the full amount. You may also need to pay a penalty fee. The recourse method is the most common type of invoice factoring.
Following our example, once 60 days have passed and Greg hasn’t paid, the factor comes back to you. They demand the full $2,000. Hopefully, you have it on hand.
Recourse factoring means you need to make certain adjustments in your books. Any recourse you need to pay a factor must be tracked as a liability.
Non-recourse factoring
With non-recourse factoring, you’re not liable for unpaid invoices. The factor buys the invoice outright and assumes the risk of non-payment.
Sounds perfect, right? Naturally, non-recourse factoring comes with a couple of caveats.
First of all, because it’s riskier, factors will charge you more for non-recourse. The difference could be as much as a percentage point—say 5% of the amount you’re factoring, vs 3.5% if you used the recourse method. And if your clients have a low credit score, those invoices might not be eligible for non-recourse factoring, since they’re a higher risk.
Second, you may still be liable. Every contract with a factor has its stipulations. It’s common for factors to only assume risk in case of bankruptcy. In that case, if one of your clients goes bankrupt, you’re fine. But if they dissolve their company and japa to Canada, you’re still on the line for the money they owe.
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