Reviewed by Aug 27, 2020| Updated on
Invoice financing is a method to borrow money against the invoices due from customers. The method of invoice financing enables the self-generation of cash flows for operational purposes to meet the expenses of salaries and other expenses.
The method also helps in saving for future investments and growth of the organisation. Customers pay the money in return for a fee which is based on a specified percentage of the invoice amount.
Understanding Invoice Financing
'Invoice Financing' also known as 'receivables financing' carries a number of benefits. It helps in early payment from trade debtors or early realisation of bills receivable. In case of goods sold under credit terms, the bills receivable specify the credit period, the due date and other terms of payment.
The credit method blocks funds for the business organisation. Hence, invoice financing helps in the early realisation of the dues.
While the credit method enables expansion of business with incremental turnover and wide customer reach, businesses may become cash-starved in the short-term to fund their future purchases. Many businesses arrange short-term financing from banks, such as overdraft to meet the short-term liquidity requirements.
An organisation may require cash to purchase raw materials, make payments to workers or contract manufacturing agreements, and other daily operations.
In such cases, an organisation may choose to either obtain outside financing or generate funds from invoice financing. The choice may be mixed too. However, the choice may vary from one organisation to another.
An organisation can improve its working capital base using invoice financing. The cash flow is useful to meet incremental business opportunities for sale and expansion.
Invoice financing can provide immediate funds to business as against outside financing. Also, invoice financing could be beneficial from a lender's perspective as the lender does not have to lend 100% of the invoice amount.
Invoice financing may be structured in many ways. An organisation may sell the invoices to a lender who buys them for 70-85% of the invoice value. In case the lender realises the entire invoice value, it may transfer the balance to the organisation. The facility of borrowing on the invoices can affect the image of the organisation where the lender collects the funds from the customers.