Invoice Financing Defined: What Is It and How Does It Work?

Invoice Financing Defined: What Is It and How Does It Work?

invoice finance definition

Instead of waiting for your customers to pay your invoices, you take out a short-term loan from an invoice discounting company. These companies will lend you up to 95% of the value of the invoices, paying you the money in a matter of days rather than weeks. Factoring (sometimes called accounts receivable financing or invoice financing) is a financing arrangement whereby a company agrees to sell receivables at their face value, less a discount, to another entity or factoring company. The purchaser of the receivables (also called the factor) then becomes the creditor of the sold receivables.

Why use invoice finance?

Invoice finance offers immediate cash flow without the hassle of paperwork or wait times. Because you are using your business's invoice(s) for collateral, there is no need to commit to monthly payments or long-term debt.

‍To apply for invoice financing, there is a lot of paperwork you need to prepare. The application process therefore requires a considerable amount of back-and-forth communication with the financier. ‍Conventional forms of lending usually require the use of cars, equipment or real estate as collateral.

Invoice Financing: Definition, Structure, and Alternative

Go through the invoice collection process to gather unpaid invoice debt. Due to the involvement by the financier with a factored customer, the advance rate on such invoices is higher than with a confidential facility. In addition, some facilities marketed as ‘confidential’ still require completion of anonymous ‘audits’ before invoices are funded. At Choco Up, we offer revenue-based financing (RBF) to fast-growing companies with a simple fee structure and flexible repayment. While a long delay between sales and payment may not cause trouble to large business sellers, smaller companies may find themselves short of cash.

It will however not be effective on the debtor if served after the debtor has paid the relevant receivable. Granting credit is not a regulated activity in Belgium provided that the purchaser (assignee) of the receivables does not solicit funds from the public. Specific rules apply to consumer credit and mortgage-backed credit to individuals for residential purposes.

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A bank line of credit will generally advance up to 75% of good accounts receivable (meaning under some aging limit–usually 60 or 90 days). Many factoring companies will offer an advance rate of 75-90% of an invoice’s face value. This higher advance rate is considered attractive by many borrowers and might justify the higher cost. A management team may choose to sell or assign this account receivable (or a specific invoice) to a factoring company at a discount to its face value in exchange for cash.

What is invoice finance and asset finance?

Invoice financing companies provide loans. The key difference between business loans made with invoice financing and loans obtained using assets as collateral, (as in a standard bank loan or asset finance), is the lender recoups the loan and their fees at source. They do not wait for the borrower to pay them.

In a notification deal, the borrower’s buyer would be notified of the transaction, meaning that the company’s payable team would be contacted with new payment instructions by the factoring company. In a non-notification deal, the buyer is completely unaware of the vendor’s financing arrangement with the factoring company. Recourse means that should a borrower’s customer not pay, the factoring company will retain “recourse” over the borrower (the vendor), meaning they can demand repayment.

Corporate Payment Undertaking

The transaction permits the borrower to have cash today instead of waiting for the payment terms to be settled in the future. Under a reverse factoring agreement, the supplier who is due payment on outstanding receivables is paid by the third-party financier known as the factor. This may be a bank or another dedicated financial institution, like Taulia.

invoice finance definition

Alternatively, there may be a deposit account control agreement (DACA), in which the financier gets security interests in your DACA bank account. The loan amount typically ranges between 80% to 95% of the value of the invoices, which you will pay back (with interest) once you receive payment from your customers. Strictly speaking, however, invoice financing and invoice factoring are not the same.

Testing and launching the Invoice Financing App

The factoring company pays you a portion of the invoice’s value and then takes over its collection. After the company receives payment from your customer, it sends you the rest of your money, minus the agreed-upon fees. With invoice financing, lenders advance a percentage of your unpaid invoice amount — potentially as much as 90%. When your customer pays the invoice, you receive the remaining percentage, minus the company’s fees.