Invoice financing VS Traditional loans:

Content Summary:

Invoice financing is different from traditional loans, and it has its own set of pros and cons. Companies can choose from the five major types of invoice financing available, namely invoice factoring, invoice discounting, selective invoice financing, spot factoring and auctioning online, based on their unique business needs.

● What is an invoice?

An invoice records a commercial transaction between buyers and sellers. A time-stamped document, the invoice typically lists the terms of the transaction as well as possible modes of payment such as via cheque, telegraphic transfer or PayNow.

There are many types of invoices such as a receipt, a bill of sale, debit note, sales invoice, and even online electronic records.

● What is invoice financing?

Invoice financing is a method to help firms improve their cash flow by ensuring that invoices get paid on time or ahead of schedule. Due to operational constraints, customers may not be able to issue payment on the products or services that they have purchased in time.

In addition, firms may also want to stay competitive by providing a longer credit term for customers, or lack the bargaining power to request for a shorter credit term from the customer. As such, invoice financing allows firms to turn invoices into cash and can be an alternative to traditional loans.

● How does invoice financing work?

As the work for an invoice is completed or as orders in an invoice get fulfilled, the firm will submit the relevant invoices to the financier, which is also known as the lending company.

The pre-agreed proportion of each invoice, which is generally at around 70% – 85% of the total invoice amount, is then processed by the financier and deposited into the firm’s bank account. The firm can then use the money to run their business by paying salaries or rent, repaying debt, proceeding with business expansion plans, and more.

Certain financiers offer firms access to cash through either a Notified or Non-notified Invoice Financing. The main difference between the options being whether the customer is aware that the receivable invoice has been pledged to a financier.

Another variation of the financial product is Invoice Financing Line, a credit line for SMEs to drawdown funds within the approved limit without going through the same submission process for each and every Invoice pledged. Invoice Financing Line (IFL) evaluates the credibility and trade transactions of SME to determine the amount of funds approved. The SME can then apply for funds drawdown in a revolving manner.

For example, where the approved limit is $1 million, SME can draw down multiple times hassle-free up to that amount and pay back the funding when their invoices had been paid by the buyer. The $1million funding limit will then be  reinstated and available for subsequent drawdowns as required to bridge the financial gap!

Depending on the invoice financing type, either the firm or the financier will collect payment from the customer of the invoice. Fees and charges are then deducted from the remaining balance before it gets remitted to or claimed by the lending company based on pre-agreed charges and fee structures.

● What are the advantages of invoice financing?

Unlike traditional loans, invoice financing typically does not require collaterals as security guarantees as the value of the invoice itself is security guarantee. This ensures that the loan history and credit score of the firm do not hamper the process of getting invoice financing. Apart from traditional criterias, Funding Societies will take into account factors such as the value of the invoice and strength of the buyer/supplier, etc.

While traditional loans often examine the firm’s business history, making it possibly difficult for new Small to Medium Enterprises (SMEs) to get loan approval, invoice financing is concerned with the value of the outstanding invoices instead. This makes it a possible financing option for young firms with a strong current position and an increasing sales volume.

Invoice financing also provides fast access to working capital since the process of invoice financing tends to be faster than that of traditional loans. Businesses can also convert up to generally 85% of their invoices into cash to use the money to tide over current business operation costs and ensure that the business can run smoothly.

Additionally, with the usage of Invoice Financing Line, SMEs can save time and effort in the funds drawdown process as the loan has been processed in advance for a certain credit line.

The loan limit for invoice financing also grows alongside the size of the firm’s business transactions. Most traditional collateral lending is limited by the value of the collateral itself, which can be restrictive, while the limit of invoice financing can increase according to the invoice value.

● What are the disadvantages of invoice financing?

While invoice financing can bring about the aforementioned benefits ,there are some considerations to take note of as well.

As firms will not receive the full 100% value of their invoices through invoice financing, there is a need to evaluate if the financing amount is sufficient enough. In addition, old invoices are typically not preferred, so firms will need to check on the invoice pre-requisites with the lending company and ensure that there is a steady stream of sufficient new invoices to maximise their funding amount.

The firm also risks becoming overly reliant on invoice financing as a financing method rather than fixing the underlying problems behind the cash flow issue. For instance, instead of developing long term solutions to communicate with clients and ensure that they pay on time, firms may just stick to using financiers to chase for payments as part of invoice financing in the interim.

There is also a chance of firms losing their ability to chase for payments in the long round, thereby losing this consumer touchpoint as a chance to further build client relationships. When the financier offers a non-notified invoice financing option to firms, the pledged invoice value serves as collateral to the financier.

The financier, however, bears the risk that the pledged invoice could be a false invoice and may have zero value. As such, stringent measures such as control account and extensive documentation may be required to lower the risk of fraudulent transactions.

● What types of invoice financing are there?

There are many types of invoice financing methods available to firms such as invoice factoring, invoice discounting, selective invoice discounting, spot factoring and auctioning online, each with their own sets of pros and cons.

○ What is invoice factoring?

A form of invoice financing, invoice factoring provides additional services, such as credit management and invoice collection management, for firms. With these credit control services, the firm can save time spent on administrative tasks and redeploy such resources into other more pressing areas of the business. This method of invoice financing is particularly useful for firms with little human resources to spare.

Through this method, firms can improve their cash flow by selling invoices to a third party (i.e: a factor, or factoring company), such as independent finance providers or banks, at a discount. However, it is important for firms to do their due diligence on the factoring companies to ensure that the financing plan fits their business requirements and operations.

An example of a financier offering invoice factoring is Funding Societies, which offer Invoice Financing Line as a product. Firms can apply for a specific amount of invoice limit (i.e: S$1million) and can pledge different invoices to draw down funds up to the agreed amount of S$1m. There are no hidden charges, and no additional limitation or obligation for clients.

○ What is invoice discounting?

Invoice discounting is similar to invoice factoring with the key difference being in the level of control that the firm has over its sales ledger. The firm can continue collecting payments and sending reminders to customers, allowing the firm to maintain their usual style of communication and customer service. This invoice financing method is useful for firms with a strong and robust credit control procedure.

○ What is selective invoice financing?

This method of invoice financing gives companies more control over which invoices to sell for an advance. Instead of sending the whole sales ledger of invoices to the lender, the firm can choose which invoice to sell. This allows firms to mitigate the write-off risk, and still maintain ownership in terms of money collection from customers.

○ What is spot factoring?

Unlike selective invoice financing whereby firms select their preferred customer invoices to submit to the lender, spot factoring requires the company to submit specific invoices, thereby granting firms even more control than selective invoice financing.

The lender also takes care of the money collections in this case. As such, both the convenience and control that spot factoring provides is why it tends to be costlier invoice financing option.

○ What is auctioning online?

To have more control over the firm’s invoice financing experience, firms can also auction their company’s invoices online. Similarly to spot factoring, firms can choose which particular invoice to finance and lenders can bid for them.

● What are the key differences between invoice financing and traditional loans?

Traditional loans add liabilities or debts to the balance sheet of the company. On the other hand, invoice financing converts assets on the company’s balance sheet into working capital.

As a whole, invoice financing typically takes a shorter time to process as compared to traditional loans, and does not need individual legal documentation or covenants for each cash advance since the paper work is already completed during the initial onboarding process.

● Getting started on invoice financing

Invoice Financing doesn’t have to be overwhelming or complicated. With Funding Societies, the financing plans are customised to your business needs.Available Invoice Financing options include Invoice Financing Line facility which speeds up the fund draw-down process as well as Supplier and Buyer Financing plans for different requirements. Customisable components include length of tenure, structure of the Invoice Financing facility offered, accessibility of funds drawdown among others.

Learn more about how Funding Societies can help SMEs tide through this difficult period with business loans, invoice financing and micro loans here .

Updated on 4th February 2021
First published on 31 August 2020