What Small Business Owners Need to Know About Invoice Financing

Invoice financing for small business owners

Bad weather and equipment repairs are notoriously damaging to your cash flow. But unpaid invoices are even worse. Tons of small business owners have to wait around for late payments to trickle in.

When you’ve got employees to pay and expenses to cover, unpaid invoices cause a major headache. After all, it doesn’t matter how much money you have in accounts receivable, you can’t use it to pay your bills. Or can you?

If you frequently have outstanding invoices stuck in accounts receivable, and you struggle with cash flow, invoice financing may be a good option for your business. Learn whether it’s the right choice for you and your finances in this overview.

One of the main reasons small businesses encounter cash flow problems is because their customers don’t pay their bills on time. In fact, research by Fundbox revealed 64% of small businesses routinely wait for late payments to trickle in.

While a padded receivables account might look great on your financial statements, you still need cash to grow your business. The good news is that thanks to invoicing financing, you can put your unpaid invoices to work for your business and overcome cash flow problems with ease.

Not familiar with invoice financing? Here are three things every small business owner should know about the modern method of small business funding.

What is invoice financing and how does it work?

Invoice financing is when you take out a loan using invoices from your accounts receivable as collateral. This gives you an opportunity to cover your expenses while you wait for a client to make a payment.

Depending on which invoice financing service you use, the process will typically go as follows:

  1. Create an account with an invoice financing service
  2. Upload information from your business management or accounting software
  3. Select the invoices you would like to receive advance payment on
  4. The money will be deposited in as little as one business day
  5. You’ll have a specific amount of time (usually 12-24 weeks) to repay the advance

Most invoice financing services charge a small fee to facilitate the loan. Some will waive it if you make payment in full before the due date.

Pros of Invoice Financing

If you have outstanding invoices sitting in accounts receivable and you need money to cover your expenses now, here are some of the benefits invoice financing can offer:

1. It allows you to borrow against your assets
Invoice financing counts unpaid invoices as assets, which means that you don’t have to apply for a small business loan or line of credit to get some quick cash.

Instead of providing your personal credit history or working through a hefty application process, all you need to do is upload your accounts receivable information and you’re good to go.

This makes qualifying for and obtaining an invoice financing loan fast and easy.

2. It doesn’t result in long-term debt
Invoice financing is meant for small loans with a quick turnaround. Unlike other business loans, you have to pay back the debt in full within a relatively short time frame.

This can be beneficial when you just need a small loan to hold you over or cover an unexpected expense since you won’t be taking on the commitment of a long-term loan from a major lender like a bank.

3. Clients aren’t notified
Invoice financing is a form of accounts receivable financing, meaning you borrow money based on existing unpaid invoices. Because you aren’t selling the client’s account to a third party, like a collection agency or invoice factoring service, the client will never know unless you tell them.

It’s a good way to maintain client relationships without letting them know you’re in a tight financial spot. This comes in handy if they typically pay on time and you want to keep them on your roster.

READ MORE: How to get started with recurring billing

Cons of Invoice Financing

While invoice financing certainly has its benefits, it also comes with a few cons. Before deciding whether it’ll work for you, make sure to review the following drawbacks to invoice financing:

1. It costs you money
Most invoice financing services charge you a fee for borrowing money. Often, this is a higher fee than what typically comes with a traditional business loan. Some lenders will waive it if you repay the debt early, but if you don’t, it will eat up a chunk of your profit. This can make a big difference when you have tight profit margins.

For example, Fundbox charges between $52 and $82 for a $1000 loan over a 12-week period. If you don’t pay off your loan early, and your profit is only $100-$200 to begin with, you’re losing a lot of cash.

2. It’s not a permanent solution
Unfortunately, invoice financing isn’t a permanent solution for chronically late invoices. While it can help you out in a bind, it won’t help you to get paid on time in the future. That’s better addressed using payment terms, late payment fees, and solid contracts.

READ MORE: Customer won’t pay for services? 5 important steps to take

3. You have to have unpaid invoices to qualify
If your cash flow problems aren’t caused by outstanding invoices, you won’t qualify for invoice financing. For example, if you have an unexpected expense or you can’t cover your employees’ wages come payroll time, and you have no unpaid invoices on file, you won’t be able to get a loan through invoice financing.

What is the difference between invoice financing and factoring?

Invoice financing is when you borrow against your accounts receivable. Clients never know that you borrowed against their invoice, and you retain the client and their debt.

Invoice factoring is when you sell your unpaid invoices to an invoice factoring company. The invoice factoring company becomes the owner of your client’s debt and it will be up to them to collect it. The client will be aware that their debt was sold.

Invoice financing works best when you have a client who isn’t consistently or unreasonably late. For example, if a client is late by a few days, or they’re getting too close to the payment due date.

But for clients who are weeks or even months past due, and who you don’t think will ever pay the outstanding invoice amount, invoice factoring may be a better option.

READ MORE: How to write an invoice that gets you paid

How do you apply for invoice financing?

Compared to traditional small business loans and lines of credit, applying for invoice financing is fast and easy. Depending on which company you use, you may need to provide:

  • Personal or business credit information
  • Financial information

But, the most important factor is your outstanding invoices. If you don’t have any, or you don’t use accounting or service management software to organize and track them, you may be out of luck.

Some invoice financing services have more lenient acceptance processes than others. For example, some don’t need to review your credit history at all while others will. Choose an invoice financing company based on your needs and financial situation to boost your chances of getting approved.

Most invoice factoring services will allow you to apply online, so once you find a company that works for you, submit an application. If you’re approved, you can expect to receive your funds in as little as 24 hours.

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This post was originally published in November 2016. It was last updated in November 2021.

Tags: FINANCE

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