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Can Invoice Financing Be Beneficial for SMEs?

Updated on :  

08 min read.

We know that the numerous government initiatives have led to a new wave of businesses budding up in the country lately. However, the availability of finances is the primary factor to keep these businesses on the sail. One such option to secure funds to keep businesses going is through invoice financing. Want to know more?

What is invoice financing or invoice discounting?

Invoice financing, also known as invoice discounting and bill discounting, is a way of borrowing short-term funds from a lender based on the outstanding invoices. Businesses use this method to raise funds to meet their day-to-day needs. This can be considered as an alternative to getting loans from banks.

Based on the invoice raised by a customer, the lender provides up to 90% of the invoice amount as funding. Such financing may be required when the business is short of cash, and their customer would pay the outstanding invoice amount on a later date. Invoice discounting will help the company keep up with purchasing more inventory, keep the business running, and deliver future orders.

How does it work?

Here is a step-by-step break up of how invoice discounting works:

Step 1: A seller sells goods to the customer and raises an invoice regarding the sale along with details, such as date of purchase, number of goods sold, and payment due date.

Step 2: Since this is a credit transaction, the customer may not make the payment until the due date.

Step 3: The seller may require cash at hand to continue serving his new orders.

Step 4: To loosen the locked-up funds, the seller may turn towards a lender who offers invoice discounting facility.

Step 5: Upon verifying the invoice, the lender may agree to pay a certain percentage of the invoice amount, ranging from 75%-90%.

Step 6: When the customer makes the payment, the difference between the actual invoice amount and the amount paid by the lender to the seller, called the ‘discounting fees’ is taken by the lender.

Step 7: Once the seller receives the payment from the customer, the seller must pay the invoice amount to the lender.

Features and benefits of invoice discounting

  • No collateral needed. Just present the raised invoice to the lender and receive the financing.
  • The seller retains the ownership of the invoices.
  • Get as much as 90% of the invoice amount as financing.
  • Quick disbursal of the financing amount.
  • Avail financing online or offline. There are many lending institutions online off-late.
  • Low-interest rate.
  • Lenient eligibility criteria.
  • Minimal paperwork as soft-copy of invoices is accepted.

Methods involved in invoice discounting

You must know that there are two methods of invoice discounting:

  1. With Recourse: The lending institution carries out a round of verification of the invoice and other documents presented by the seller and gets it verified by the seller’s bank. If the seller’s bank declares that the seller has defaulted, the seller may be held liable for bad debts.
  2. Without Recourse: The lending institution will not carry out any verification on the invoice and other documents presented by the seller. Nor does the lending institution check with the seller’s bank.

Documents required

  • Aadhaar card
  • PAN card
  • Name and address of the business
  • Business registration certificate
  • GST registration certificate
  • Proof of previously filed GST returns
  • A copy of the business bank account statement for the past six months
  • Ledger of debtors
  • Audited financial statements of the business

Frequently Asked Questions (FAQs)

What factors are considered to provide invoice discounting?

Some of the factors on which invoice discounting depend are:

  • The financing amount required for the business
  • The financial turnover of the company so far
  • The customer base of the business
  • The total outstanding amount of invoices
  • The brand name or visibility of the business
Are there specific sectors/industries that are eligible for invoice financing?

The invoice financing is available for businesses from a wide range of sectors/industries, such as construction, retail, logistics, printing and publishing, transportation, consumer goods, and so on.

Why should I prefer invoice discounting?

Invoice discounting lets businesses keep going without having to worry about cash crunch or applying for tedious business loans. This short-term financing option helps you secure cash without the need for collateral and eases the locked-up money from the outstanding invoices. Instead of chasing your customers for bill amounts, you can let them handle their finances freely and still have some cash at hand for your day-to-day business expenses.

Does this financing method work for new and small businesses?

Yes, many lenders in the market accept applications from newly set up small businesses and finance their invoices. The lenders look at the current sales volume of your business and the potential for growth as the significant factors in approving the financing.

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