What is Invoice Financing?

2 min read

Unpaid invoices can block your working capital. Invoice financing is a credit facility that allows a business to borrow money using high-value unpaid invoices as collateral. This way, you can get the funds you need to meet immediate cash flow requirements to purchase inventory, repay dues, pay vendors or employees, meet marketing expenses, repay debt and more.

Get a loan against your uncleared invoices at an attractive interest rate from Bajaj Finserv. Our invoice financing loan is easy to apply for with a simple online application form and minimal paperwork. It keeps your repayment comfort and business needs in mind with a flexible tenor and fast approval as well as disbursal.

Our pre-approved offers make invoice financing faster and quicker for existing customers.

How invoice financing works

Invoice financing is a straightforward way for businesses to get immediate cash flow by using outstanding invoices as collateral. Here is how it works:

Step 1: Submit your invoice to your lender

You begin by submitting the invoice you want to finance to your lender. The invoice should be for goods or services that your business has already provided, and it must be due for payment by your customer within a specific timeframe.

Step 2: The lender advances you funds

Once the invoice is approved, the lender provides you with a percentage of the invoice amount—usually between 70-90%. This allows your business to access cash quickly, without waiting for the customer to settle the invoice.

Step 3: You collect payment from your customer

While the lender has advanced you the funds, you continue to collect payment from your customer directly, just as you normally would. The customer is still responsible for paying the full invoice amount.

Step 4: Repay the lender, with fees

Once the customer pays the invoice in full, you use those funds to repay the lender, including any interest or fees agreed upon upfront. The remaining balance is returned to you.

Invoice financing example

Here is an example explaining how invoice financing works:

Step 1: Invoice is submitted

Let us say you are going to finance an invoice worth Rs. 75,00,000 with 30-day terms. You submit this invoice to a lender.

Step 2: Funding is received

The financing company approves your invoice submission and gives you an advance of 90% (Rs. 67,50,000).

Step 3: Fees are charged and you collect payment

The company charges a 2% fee for each week it takes your customer to pay the invoice. If the customer pays in two weeks, you owe the lender a Rs. 1,50,000 fee (2% of Rs. 75,00,000 for each week).

Step 4: You repay the lender

After the customer pays the invoice, you keep Rs. 1,50,000 and send Rs. 69,00,000 (the original advance amount, plus fees) to the lender. You have paid Rs. 1,50,000 in fees, which calculates to an approximate APR of 53%.

Structure of invoice financing

Invoice financing can be structured in two primary ways: factoring and discounting. In invoice factoring, a business sells its unpaid invoices to a lender, receiving an advance of around 70% to 85% of the invoice value upfront. Once the lender collects the full payment from the customers, the remaining 15% to 30% is transferred back to the business after deducting any fees or interest. Since the lender directly interacts with the customers for payment collection, this arrangement is transparent to the customers and may impact the business’s reputation.

Invoice discounting, on the other hand, keeps the transaction discreet. The business remains responsible for collecting payments from customers, making the arrangement invisible to them. Under this method, lenders typically advance up to 95% of the invoice value. Once the business collects payments, it repays the lender the advanced amount along with applicable fees or interest.

Pros and cons of invoice financing

Pros of invoice financing

Best suited for B2B and seasonal businesses: Invoice financing is particularly effective for businesses dealing with other businesses, as it relies on unpaid invoices for funding. It is an excellent solution for resolving cash flow challenges caused by pending payments
Invoices act as collateral: Since invoices secure this type of financing, qualifying is often easier compared to other loans. Lenders primarily assess your customers' payment history, making it a viable option for startups or businesses with low credit scores
Quick access to funds: Most invoice financing providers have simple application processes with minimal documentation, enabling businesses to secure funding within 24 hours. This speedy process is invaluable during cash flow shortages or emergencies

Cons of invoice financing

High costs: While initial fees may seem competitive, typically 1% to 5% of the invoice value per month, the effective APR can reach up to 79%. This is significantly higher compared to alternatives like SBA loans, which have APRs ranging between 10.75% and 14.25%
Dependence on customer payments: Fees are calculated based on how long customers take to settle invoices, making total costs unpredictable. Delays or missed payments can lead to additional charges, and if a customer defaults, the financial risk falls on your business
Restricted to B2B operations: Businesses that sell directly to consumers are generally ineligible for this financing, as their sales typically involve immediate payment, leaving no outstanding invoices to leverage

How to get invoice financing

Here is a detailed guide on getting your invoice financing done:

Step 1: Check your eligibility

Before applying for invoice financing, ensure your customers have a solid track record of timely payments and good creditworthiness, as lenders place significant emphasis on this. While customer reputation is key, most lenders will still assess your personal credit score, business finances, and time in operation. Stronger qualifications can improve your chances of securing higher loan amounts and favourable rates.

Step 2: Research and compare lenders

Invoice financing is typically offered by online lenders and FinTech companies, as banks rarely provide this option. Compare lenders based on loan limits, rates, eligibility criteria, funding speed, reputation, and customer support. Examples include:

Upwise capital: Offers up to 100% of invoice value with interest rates from 8% to 30%. Requires one year in business, Rs. 1.2 crore annual revenue, and a personal credit score of 600+.
Porter capital: Provides accounts receivable financing with quick online application and decisions within 24 hours. Rates vary based on qualifications.

Other options include AltLINE and Triumph Business Capital, which specialise in invoice factoring.