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Invoice financing allows a small business to take out a loan based on its unpaid invoices. It’s typically a fast way to get funding and can be easier to qualify for than other loan options, but it’s also a fairly expensive solution.
Invoice financing is sometimes confused with invoice factoring, but it’s important to understand the difference. Invoice factoring involves selling your unpaid invoices to a factoring company, whereas with invoice financing, you maintain control over your invoices and are responsible for collecting payments on them.
Key takeaways
What it is. You borrow against unpaid customer invoices to smooth cash flow, typically advancing 70%–90% now and the rest (minus fees) when the invoice is paid.
Speed vs cost. It’s fast to set up and fund but pricing can be high with factor fees that grow the longer customers take to pay.
Who qualifies best. Works for B2B firms that invoice creditworthy customers on net terms — not for consumer invoices or cash-on-delivery sales.
Watch the fine print. Some providers “notify” customers and handle collections which can affect relationships, and many deals are recourse if a customer never pays.
What is invoice financing for small businesses?
Invoice financing — also known as accounts receivable financing, invoice discounting or receivables financing — is a type of small business funding where a company borrows money using its outstanding invoices as collateral. It’s essentially a cash advance based on a percentage of your unpaid invoices, which you’ll repay when your customers settle their bills.
Invoice financing offers a fast influx of capital often used to handle immediate cash flow needs, such as covering payroll or purchasing inventory. It’s also typically easier to qualify for compared to more traditional loans. Plus, it allows business owners to take advantage of time-sensitive opportunities without going through a lengthy lending process.
How does invoice financing work?
Invoice financing basically works in three steps.
Submit an outstanding invoice or invoices to a lender.
The lender extends a loan based on a percentage of the value of those invoices, typically up to 90% of the amount owed.
You repay the loan amount, plus interest and/or fees as your customers submit payments.
For a simple example, let’s assume you have an outstanding invoice of $100,000. You submit it to a lender that agrees to extend you a loan of $90,000 — 90% of the invoice total — at an interest rate of 5% of the loan amount. When you repay the loan within the agreed-upon timeframe, you’ll owe $94,500 ($90,000 loan amount + $4,500 in interest).
How much does invoice financing cost?
Invoice financing is typically a more expensive form of financing than more traditional business loans. While exact fee structures depend on the lender, you might expect to pay an interest rate between 1% and 5% of the loan amount. Some lenders may charge a rate based on the face value of the invoice.
A rate of 5% may seem reasonable, but when you factor in that invoice financing is typically a very short-term loan, the effective APRs can reach well into the double digits.
Plus, keep in mind that some invoice financing lenders may also charge fees on top of interest, such as application or administrative fees. In addition, you’ll be on the hook for late fees if your customer doesn’t pay on time and you don’t have enough to cover the payment. To keep costs down, it’s critical to only finance invoices from customers that always pay on time.
Who is invoice financing best for?
Invoice financing makes the most sense for small businesses with a lot of cash flow. More specifically, invoice financing is ideal for business-to-business (B2B) firms or companies with a steady stream of reliable, repeat clients.
Pros and cons of invoice financing
Pros
Cash flow. Provides funds that can be used to cover day-to-day operating costs, inventory purchases or other business needs.
Fast access to funds. Borrowers receive funding based on unpaid invoices in as little as a day or two.
Easier to qualify for. Invoice financing relies more heavily on the value of your invoices than your credit history or business financials.
Maintain control of customer’s invoices. Unlike invoice factoring, invoice financing leaves you in control of your invoices, which helps maintain your customer relationships.
Cons
More expensive. Invoice financing is typically more expensive than other forms of business funding like term loans or lines of credit.
Potential risk of delayed customer payments. If your customers delay paying their invoices, you may not be able to cover your loan payments and incur pricey late fees.
Typically only suitable for B2B companies. Invoice financing isn’t possible for companies that don’t send invoices to their customers, like businesses that sell directly to consumers.
How to get invoice financing
Not every business is suitable for invoice financing, so you’ll want to assess your business and consider your loan options.
Evaluate your invoices. Consider if you have a steady stream of customers paying by invoice and the amount you expect to bring in regularly.
Compare lenders. As you compare multiple lenders, consider interest rates and fees charged, in addition to loan terms and conditions, to find the best deal.
Apply. You may be able to apply for invoice financing entirely online, but be prepared to provide financial information about your business and details about your customers. A credit check may also be required.
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Lenders consider these factors to determine if you qualify for invoice financing:
The total of your outstanding invoices
The loan amount you’re seeking
The type of business you’re in
How long you’ve been in business
The type of customer base you have
The reliability of your customers
Invoice financing vs. invoice factoring
Invoice financing is often confused with invoice factoring, but there are some key differences. While both financing options consider your invoices to qualify, invoice factoring involves selling your outstanding invoices to a factoring company, whereas invoice financing allows you to retain control over your invoices.
A factoring company takes possession of your invoices, pays you a percentage of the invoices’ value and handles the collection process. Once a customer pays, the factoring company sends you the difference minus its fees.
Invoice factoring might make sense if you don’t mind having someone else handle the collection process and aren’t worried that using a third party will harm your connection with customers. However, if you prefer to maintain close relationships with your customers, invoice financing might be a better choice.
Alternatives to invoice financing
Invoice factoring is one alternative to invoice financing, but it’s not your only option.
Merchant cash advances (MCAs). Another form of short-term funding, merchant cash advances allow you to borrow based on a percentage of future credit and debit card sales.
Business lines of credit. A business line of credit can help you meet cash flow shortages and other business needs, although you may need a good credit score to qualify.
Business credit cards. Business credit cards may be easier to qualify for than some other forms of financing, but business cards won’t give you ready access to cash.
Microloans. If you’re looking for a relatively small loan, you might be able to get a fast, short-term microloan from online lenders or nonprofit business loan lenders.
SBA loans. Loans backed by the Small Business Administration may be a more affordable option, but the SBA loan process can be lengthy and difficult to qualify for.
Equipment loans. If you were planning to use your loan proceeds to purchase tangible assets for your business, an equipment loan might be a good option. Plus, the equipment acts as collateral, so even borrowers with bad credit may qualify.
Purchase order financing. If you’re looking to cover the costs of manufacturing specifically, this type of short-term financing can help you pay any third-party suppliers.
Bottom line
If you’re a small business owner with a lot of invoiced customers, invoice financing might be a good solution. It can help cover cash flow shortages or take advantage of growth opportunities. Funding is typically fast, and your loan is secured by your customers’ invoices.
But it is an expensive form of short-term funding, and it’s not feasible for all types of businesses. If invoicing financing doesn’t work for your company, consider other business loans or alternative forms of business funding.
Frequently asked questions
Can I finance any of my invoices?
Not all invoices are necessarily eligible for financing. Your lender assesses your invoices and lets you know which ones qualify. For example, a customer with an invoice history of late payments may not be eligible for financing.
What documents do I need to apply for invoice financing?
Aside from providing your customer invoices for approval, you may need to provide other documentation, such as recent bank statements, personal and business credit scores, tax returns or business financial statements.
Do I need to provide my bank account information to invoice financing lenders?
In most cases, you need to provide your account details to lenders. Most are online lenders and need your banking information to deposit your funds electronically. Lenders may also want to look at your business bank account to view your balance and transaction history.
Lacey Stark is a freelance personal finance writer for Finder, specializing
in banking, loans, investing, estate planning, and more. She has 20
years of experience writing and editing for magazines, newspapers, and
online publications. A word nerd from childhood, Lacey officially got her
start reporting on live sporting events and moved on to cover topics
such as construction, technology, and travel before finding her niche in
personal finance. Originally from New England, she received her
bachelor’s degree from the University of Denver and completed a
postgraduate journalism program at Metropolitan State University also
in Denver. She currently lives in Chicagoland with her dog Chunk and
likes to read and play golf.
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