Invoice Financing

DEFINITION of 'Invoice Financing'

A way for businesses to borrow money based on amounts due from customers. 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 them. Businesses pay a percentage of the invoice amount to the lender as a fee for borrowing the money. Invoice financing can solve problems associated with customers taking a long time to pay and difficulties obtaining other types of business credit.

BREAKING DOWN 'Invoice Financing'

Invoice financing also benefits lenders because unlike extending a line of credit, which is unsecured and leaves little recourse if the business doesn’t repay what it borrows, invoices act as collateral for invoice financing. The lender also limits its risk by not advancing 100% of the invoice amount to the borrowing business. Invoice financing doesn’t eliminate all risk, though, since the customer might never pay the invoice, which could result in a difficult and expensive collections process.

Invoice financing can be structured in a number of ways, most commonly factoring or discounting. With factoring, the company sells its outstanding invoices to a lender, who might pay the company 70% to 85% of what the invoices are worth, up front. Assuming the lender receives full payment for the invoices, it will then remit the remaining 15% to 30% of the invoice amounts to the business, and the business will pay interest and/or fees for the service. Customers will be aware of this arrangement, however, which might reflect poorly on the business.

As an alternative, a business could use invoice discounting, which is similar to invoice factoring except that the business, not the lender, collects payments from customers, so customers are not aware of the arrangement. With invoice discounting, the lender will advance the business up to 95% of the invoice amount. When clients pay their invoices, the business repays the lender, minus a fee.