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Business owners are known for getting creative when it comes to financing. Sometimes it can really be hard to get the funding that you need to help keep operations going. This is especially true if you have large orders to fill but limited capital to get them done. Most clients only pay invoices once you have completed an entire order, and this can be difficult to do if you’re a new company with limited resources. Taking a big order may be vital to your success as a company, but it can also be impossible in certain circumstances. Many businesses will turn to credit lines or term loans to try and get financing, but there are also other ways that you can use your invoice to get the capital you need.
Borrowing money has a stigma against it, but modern-day finance is the reason that many businesses are able to thrive. It’s almost impossible to have all the capital you need to start a well running business – you need to have help from a lender to make sure you can operate efficiently. Even if you have already fully set up your business including your office, equipment, operational needs, machineries and more, you may still need money to make all of these work. This is precisely why business owners need to maintain a working capital. That initial investment you have made for your business simply might not be enough. In some cases, business owners realize that they lack funds even before they are able to collect their earnings from sales or services they produced. In that case, an invoice financing type of small business loan can be a great option.
This is a unique loan that is borrowed against an invoice you have for a client. It is also sometimes referred to as an accounts receivable loan. This is the perfect way to get money for upfront costs if you already have a big invoice. This type of financing works well for specific industries which will be further explored later in this page. Read on if you’d like to know more about invoice financing and how it may be able to help your business improve its capabilities.
Simply explained, invoice financing is a type of loan that allows you to borrow money in advance — the same amount that you’re supposed to get from an account receivable that you’re expecting. Of course, there are fees associated with getting invoice financing loans. In many cases, these fees are higher compared to traditional financing such as term loans. The fees are calculated according to how long the lender should wait before the invoice will be fully paid off.
The good thing about this is that you don’t have to wait for your client’s payments or for that invoice to be fully paid. You don’t have to assign a different collateral anymore, as that invoice itself will be the collateral for this type of business loan. If you have a bad credit score, that doesn’t matter much if you apply for invoice financing because the credit check will be on the invoiced business. The downside to that is if the business that provided you with an invoice has a bad credit score — there’s still a chance your application won’t get approved.
For invoice financing, you won’t get the full amount as stated on the invoice, rather you will be entitled to approximately 50 to 90%. For instance, if you have a $10,000 invoice, you can get $5,000 to $9,000 in advance. The remaining balance minus the fees will be given to you in full as soon as the invoice has been fully paid by your client. For example, if you are getting $7,000 out of $10,000, you will only receive the $3,000 minus the fees the moment the invoice has been paid.
Are You Qualified to Get Invoice Financing?
If you have a business dealing with other businesses, you may be qualified for invoice financing. It doesn’t matter what your business is or what that invoice is about, for as long as it came from a legitimate business that is obligated to pay you back, then you can get approved.
For instance, if you have a small business selling used cars and someone loaned a car from you, if that someone is an individual and not a business, that invoice does not qualify.
Here’s an example: you supply commercial printers to various businesses. A company ordered several large printers, which amounted to roughly $10,000. They aren’t paying you with cash, rather they’re paying you with an invoice that will be valid, say 45 days from the time the invoice was presented. If you already need the cash but that client cannot give you $10,000 upfront, and you don’t want to lose their business simply because you can’t wait for the money, then you can turn to invoice financing.
Simply put, these lenders aren’t too keen on your profitability, your credit score or even your business revenue. You simply need to present that invoice, then the lenders may countercheck the credit score of your client just to be safe on their end. After all, that invoice will be the collateral for this loan.
Invoice Financing Basics
Perfect for those with bad credit – Whether you have a low credit score or if you recently put up your company, you can apply for invoice financing. More often, this type of loan product comes in helpful to new businesses that don’t have a lot of working capital yet. For instance, if you operate a marketing business and closed a $20,000 deal with a client and they are paying you through an invoice that will be fully pain in 12 weeks’ time, you might be in the losing end especially if you don’t have a lot of cash to work with. Of course, you need funding for your business to operate and to push through with the work you will be doing for them. In that case, you may request for invoice financing.
Worried About Your Customer’s Score, Not Yours – Because invoice financing is based on your customer’s ability to pay their invoice, the lender is much more concerned about their credit score than yours. This is because they will want to make sure that the loan is going to be able to be repaid via the invoice. They’ll want to make sure that the company that you’re invoicing is reliable and has a good history of paying their bills. This is why you should choose a company that you can exhibit has a good record of fulfilling financial duties – a long term customer of yours will most likely be best.
Fast and Reliable – The best thing about invoice financing is that you can get cash quick, in as little as 24 hours, and it is very reliable. It is almost always available as there are many lenders offering this loan product and there are minimal requirements that you have to submit.
No Upfront Fees – Another advantage of invoice financing is that you won’t be asked for upfront fees more often than not. As we mentioned earlier, you can get as much as 50 to 90% of the invoice amount upfront. The lender will hold onto the remaining balance because this is where they will be deducting those fees later on. If your client fails to pay on time or if they take a while to make payments, then those fees can build up. To secure their finances, the lenders need that balance to cover the risk on their end.
100% in advance – Good news is we’ve seen some lenders offering 100% of the amount of the invoice. How do the lenders make this possible? You will then have to make payments, often weekly, to the lender directly over a certain time period, until the advance has totally been cleared. By the way, it is good to know that if this is the type of invoice financing loan you get, there are instances when the lender requests payments directly from your client. This isn’t exactly a good thing especially if you are still building a relationship with a potential long-term huge client of yours.
Fulfill Orders Efficiently – If you are having problems funding your orders there is a high chance that you won’t be able to fill them efficiently. This can have negative effects on your business down the line if you end up having a reputation of being unprofessional. Using invoice financing can help you
Keeping Your Assets Safe – Another great thing about many invoice financing loans is that you don’t have to put your assets at risk. Many term loans require you to use your company’s assets to secure the loans you receive. In some cases, you may even have to use personal assets as collateral against what you borrow. This is extremely risky as you’re potentially putting your family’s livelihood at risk
Is Invoice Financing Even Worth It?
If you only have to wait for a short while before an invoice gets paid, then you might think that having to pay for fees to a lender can be quite impractical. After all, you can hold on to that invoice and get 100% of the payment if you just waited a while. So is invoice financing even worth it?
Having extra cash flow especially if you don’t have plenty of funds for your business to begin with is always a good thing. Even a few weeks’ waiting time can mean a lot if you’re already supposed to shell out money for a number of other expenses. That alone will give you enough reason to think that invoice financing is worth it.
To make you feel better about it, think of it this way—you’re not getting the full payment right away. Perhaps you will be charged 5 or even 10% or more by the lender after the invoice has been paid in full. Would you have given your client a 5 or 10% discount if they actually paid you in cash upfront versus if they asked you to wait for 25 weeks or so? We believe so. It will still be worth it, right?
Industries That Use Invoice Financing
Invoice financing is a great tool but it works best for certain industries. If you’re considering using invoice financing as a means for attaining funding, you should probably ensure that it is a viable option for the type of business you have. Below is a list of the industries that most commonly use invoice financing. Keep in mind that if you don’t fall in this list, it doesn’t mean you can’t use it – do some independent research to see if you may be a good candidate for invoice financing.
- Freight/Trucking – If you work in any form of freight or delivery industry, invoice financing tends to be a good option. This is because shipping contracts happen over prolonged periods of time. For example, if you have a contract with a customer, you may be providing them with services over a six-month period. You can use a loan to help finance this before you end up getting paid for the services.
- Staffing – If you work in the staffing industry you may be looking at providing employees to a customer over a prolonged period of time. If you don’t want to bill your client every time you provide them with employees, you can use a loan to help fund the recruitment costs before you bill out.
- Production – If you produce a good, but you normally ship out large orders, financing your invoices may be a good way to help get the funding that you need. This is especially true if you’re producing large products that take time to manufacture.
- Oil & Gas – If you produce natural resources, chances are you are selling large amounts of resources to your clients. It can be expensive to produce these resources and you may need to get a loan to help get funding to continue your operations.
- Construction – If you work in construction, you probably deal with large projects that take time to complete. Instead of asking for capital upfront from your client, you can use a loan to help fund the materials and labor that you need to complete the project in a timely manner. This will also help you improve the reputation of your business.
- Consulting – Consulting is another industry that has long term projects. You will most likely be working with clients to solve complex and time consuming problems – using a loan to help fund the cost of your work will improve your ability to operate effectively.
- Agriculture – If you work in agriculture you will most likely have seasonal gaps in cash flow that result when you are trying to produce your products. It takes time to grow, harvest, and distribute agricultural products. At the same time, you will most likely have regular orders in place from your clients. You can borrow against these invoices to help fund your operations in the offseason.
Industries That Don’t Use Invoice Factoring
Just as there are many industries that mesh well with invoice financing, there are also others where this doesn’t tend to work as well. It is important to be aware of whether you fit into one of these categories – you may be wasting your time researching this form of financing if it is not a viable option for your business. This being said, make sure to do independent research to see if your company is viable – there are exceptions to this list. Below are some common industries that don’t typically support invoice financing.
- Hospitality – If you work in hospitality, the chances that invoice financing will be of use to your company is low. This is because you are most likely running a restaurant that relies on individual customers to come in a and purchase drinks and food. On the other hand, if you run a catering company that has contracts with commercial companies, you may find that you can use invoice factoring.
- Tourism – Tourism tends to be similar to hospitality in the sense that if you run a small business that relies on tourism, you probably don’t have invoices that you can use to attain finance. Larger tourism companies may be able to use invoice factoring but as a rule of thumb, small businesses operating in tourism tend not to receive this benefit.
- Retail – If you run a small retail operation, chances are that invoice factoring won’t be a good option for you. You’re most likely selling clothing or other products directly to customers in small quantities – this is not a suitable business model for invoice financing.
If you’re considering invoice financing, there are also some alternatives that may be worth considering. A similar type of funding mechanism is called invoice factoring. Instead of getting a loan against the invoice, you actually sell it to a company that then owns the rights to collect it. This can be advantageous for a number of reasons. First of all, you don’t actually take on any debt – your balance sheet remains the same as you are simply selling the rights to collect the invoice. This can be good for your business if you already have a large amount of debt that you’re trying to offset.
Factoring companies typically will be able to give you up to 90% of the invoice total, which means you may end up with less upfront capital than you would with an invoice finance agreement. But once they collect the invoice, they will give you additional money – they typically take about a 3% cut of the total invoice amount. This is typically used for invoices that are large in nature. There are various industries that use invoicing frequently, including manufacturing, freight, and staffing. This is often because these industries have invoices that span over long periods of time. If you have a contract that runs over an extended period of time, it may be best to sell it to someone in advance so that you have the working capital you need to fulfill the order.
The major downside with factoring, which doesn’t happen with traditional invoice financing, is that your client will be notified that you have sold on the invoice. This is because the factoring company will be collecting the invoice directly from your client. This can appear negatively on you as it may seem that you are struggling financially – this could hurt the reputation of your business. If you do decide to factor an invoice it is best you speak to your client first and let them know the reasons you are selling it on.
Invoice Financing: A Short-Term Solution
As you can see there are many great advantages to using invoice financing in your business. But it must be mentioned that the consensus is that invoice financing should be a short-term solution, not a long term one. In truth, it is not a good idea to constantly rely on invoice financing to pay for the costs of fulfilling orders. Eventually, a sustainable business model should be built that will make your company less reliable on the cost of financing when it comes to production. Invoice financing is great for new small businesses that have yet to be able to get the money they need to fulfill their orders. It’s also a great short term funding solution for a business that gets a large order that they don’t have the current capacity for.
After reading this page you probably have a firm grasp on the concept of invoice financing and how it can help improve your business. If you fit into one of the categories that this type of finance works for, you’re most likely wondering how to get the ball rolling. As with any form of finance, you should check out multiple lenders and get quotes from each one before you decide to move forward. There are plenty of great online lenders that have moved into the invoice financing space – head online to make some comparisons.
It’s really important that you ask for a full break down of the loan costs. You may be looking at a favorable interest rate, but that doesn’t mean you are looking at the total cost of the loan. The best way to compare competitors is to ask for the total cost of the loan, not the interest rate. Consider trying a business loan calculator as well. You should also make sure to check customer reviews on consumer watchdog groups – using a lender with a bad reputation can result in truly horrible experience.
Lastly, keep in mind that you don’t have to finance the entire value of your invoice. You’re able to borrow partially if it makes more sense or if you don’t need too much money.
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Jason is a Senior Author for SBL. He has been working with small business owners like you for the past ten years. He graduated with an MBA and began a career as an independent financial consultant for small businesses in his state.