What is Invoice Financing and How Does it Work?

Business 17 January, 2022

The economic recovery from the coronavirus pandemic has been painfully slow and disrupted to date, cutting off many businesses established revenue streams in the process.

It’s fair to surmise that the coronavirus crisis has also changed the whole lending landscape once again on these shores, encouraging firms to seek out accessible and low-cost funding in addition to supplemental government support.

This includes invoice financing, which is a particularly popular borrowing method in the current climate. But what exactly does this refer to, and could it benefit your business?

What is Invoice Financing?

The term ‘invoice financing’ may also be described as receivables financing or invoice discounting.

It describes a short-term lending option that allows a business to ‘sell’ their accounts receivable to third parties, creating a stream of income that’s effectively borrowed against outstanding invoices.

This short-term debt is then repaid once the client has settled their invoice, with applicants able to secure this type of funding again in the future if they desire.

Typically, invoice financing allows money to be borrowed for a period of up to 90 days, providing an immediate injection of cash and working capital into a functioning business.

This negates the need to commit to a long-term loan, enabling new and smaller ventures to minimise the amount of debt within their models (we’ll have a little more on this later in the piece).

Ultimately, the main objective and purpose of invoice financing is to unlock revenue that’s otherwise tied up in outstanding invoices, which may be subject to various terms depending on the industry in which you operate and the demands of individual clients.

There’s also some flexibility associated with invoice financing, as you can choose to put your whole ledger through the provider or select a few higher-value items to optimise cash flow levels while minimising short-term debt further.

Is Invoice Financing Right for Your Business?

As we can see, invoice financing can provide an excellent way of improving and optimising cash flow, while it offers a short-term stream of income that doesn’t saddle a business with long-term debt.

But in what circumstances is it most helpful? Well, if your business provides products or services to clients on 60 or 90-day invoice terms (which may be important if you’re to be competitive in your chosen market as a startup), invoice financing allows you to successfully power your startup and avoid the primary issues that curb many new businesses during their first year.

Similarly, there may be instances where your business boasts high or inflated operational costs, in which case optimal working capital is required at all times.

Sure, your venture can reduce operational costs as it scales, but in the meantime, invoice financing offers an excellent method through which to fulfil orders and remain competitive.