Invoice Financing: How it works? Types, and Differences
In recent times, invoice financing has gained popularity owing to reasons like instant availability of collateral-free funding and hassle-free application process. At 10% of total credits from financial institutions, invoice or bill financing can make a significant difference in bridging the working capital deficits of businesses.
The process of availing funds is further simplified with KredX, one of the most promising invoice financing companies in India.
What is Invoice Financing?
Invoice financing in India refers to the process through which businesses can avail advances against outstanding invoices from their customers. In turn, businesses pay a certain percentage of this total invoice amount as a fee to their lender.
Through this method of financing, businesses can meet their short-term liquidity requirements by availing a percentage of the value of their unpaid invoices as a loan. These unpaid invoices are considered as accounts receivables. It means that businesses will receive the stipulated amount against invoices raised, but at a later date.
Utilising this method to avail funds, businesses can improve their cash inflow, invest in operations to foster growth, pay their suppliers and employees, and see to a host of other financial needs. Invoice financing helps companies do away with the necessity to wait for customers to settle bills and gain access to necessary funding readily, thus making them a popular form of financing sought by businesses. A customer questionnaire performed resulted in 22% of the respondents favouring bill financing as a convenient mode of instant funding.
How Does Invoice Financing Work?
Before opting for invoice finance, it is crucial to learn how the entire funding process is carried out. Here’s how it works.
Most businesses usually sell their goods and services to their customers (like retailers and wholesalers) on the basis of credits. It means that customers do not usually pay upfront for such goods and services, and are instead charged at a later date. Now, when the business sells its goods or services to customers, it generates an invoice payable within 30-90 days. Invoice financing is the process through which businesses can avail instant funding against such invoices, by following these steps –
- Once an invoice is generated, businesses forward it to the chosen financier.
- The financier then reviews this invoice and disburses a percentage of its value as a loan to the business within 24-72hrs*(varies from one lender to another).
- The business can then wait for the customer to settle the outstanding invoice amount. If unpaid, the business owners can pursue such payments, or get the financier to do it on their behalf, depending on the agreement.
- Once this invoice is settled by the customer, businesses receive the remaining percentage of their invoice’s value, sans the stipulated service fee levied by the financier.
Invoice financing thus allows businesses to mobilise the capital which would otherwise have been held up in unpaid invoices.
Types Of Invoice Financing
As a business owner, you can opt for two types of invoice financing. These are invoice factoring and invoice discounting.
While both these types of invoice finance operate along the same principles, their lending structure is different.
Also known as debt factoring, this particular type of financing enables businesses to avail capital by selling their unpaid invoices to a third-party factoring company.
The factoring company (financier) purchases these invoices for a certain percentage of their total value and takes over the responsibility to collect payments against these invoices.
Invoice discounting, on the other hand, is carried out under confidentiality. In this process, the business’s customers are not aware of the fact that their unpaid invoices are being utilised to raise funds.
Here, the business has total control of the sales ledger and is committed to the task of collecting the outstanding amount against invoices from customers.
Nonetheless, irrespective of the type of invoice finance one opts for, he/she can avail up to three times more cash through it than with other forms of financing.
Invoice Financing Example
Invoice financing is a financial solution where businesses use their unpaid invoices to secure immediate cash from a financing company. Here's a simplified example to illustrate how it works:
Company A Provides Services to Company B
Company A completes a project or delivers goods to Company B and issues an invoice for ₹1,00,00,000 (1 crore rupees). The payment terms are 60 days.
Company A Needs Immediate Cash
Instead of waiting 60 days for payment, Company A needs funds right away to pay for operating expenses, invest in new projects, or manage cash flow.
Company A Approaches a Financing Company
Company A approaches a financing company specialising in invoice financing. It presents the unpaid invoice as collateral.
Financing Company Advances Cash
The financing company assesses the creditworthiness of Company B (the invoice debtor) and agrees to finance the invoice.
It advances a percentage of the invoice value, say 80%, to Company A. In this case, Company A receives ₹80,00,000 immediately.
Fee and Balance Payment
The financing company charges a fee for this service, for example, 2.5% of the invoice value.
When Company B pays the invoice, the financing company collects the full amount of ₹1,00,00,000.
After deducting the advanced amount (₹80,00,000) and the fee (₹2,50,000), the financing company transfers the remaining balance (₹17,50,000) to Company A.
This example illustrates how invoice financing in an Indian context can provide businesses with swift access to working capital by leveraging unpaid invoices, thereby helping them maintain a steady cash flow.
How To Qualify For Invoice Financing
Eligibility for invoice financing requires a business to possess accounts receivable from reliable customers known for timely invoice payments. While the primary focus is on the creditworthiness of these customers, the company's credit score and fundamental business health are also considered. A business owner's weak credit score may hinder approval from some financing companies, or could lead to increased costs and fees in certain scenarios.
Differences Between Invoice Factoring And Invoice Discounting:
To understand how each of these types of invoice financing function, it is crucial to learn the differences between the two. Following is a table that illustrates how these methods of borrowing against debt differ from each other.
Control and visibility
Through factoring, the financier manages the credit-control process, as well as the business’s sales ledger.
Financers subsequently pursue customers over unpaid dues, allowing businesses to do away with the hassle of checking on their customers for such collection.
With invoice discounting, businesses retain the control of their sales ledger alongside credit control and collect payments themselves. Furthermore, customers are unaware of the invoice discounting agreement between businesses and financiers.
Adjustments made to funds disbursed
Under this arrangement, businesses are offered funds in advance against individual invoices. Adjustments to the funds disbursed are made daily.
Under discounting, financiers renounce control over the business’ sales ledger. Thus, any changes to the funding amount disbursed are made on a monthly basis, after businesses provide the monthly reconciliation of their invoices.
Despite these differences, both these types of invoice financing can be extremely handy funding avenues for businesses irrespective of the industry or sector they belong to.
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Best Invoice Financing Company In India:
The last few years have been witness to the emergence of several invoice financing companies in India. Among them, KredX is India’s leading invoice discounting marketplace that offers working capital for businesses against unclear invoices with completely transparent terms and conditions.
Business owners can easily opt for invoice discounting through our online platform and avail funds instantly against the value of their invoices. Here’s how the process works –
- Customer raises an invoice, typically payable between 30 - 90 days.
- He/she needs to sign up and upload the invoice at our portal.
- Loan is approved against the invoice value and disbursed to the customer’s account within 24-72 hours*.
The external investor, in turn, receives payment when the invoice is paid out at the end of the tenure.
With this extremely streamlined process, businesses can avail funds in no time and address their financial requirements without hassle. Thus, with working capital readily available, businesses no longer have to undergo downtime in receiving funds regularly and can keep their cash flow steady throughout.
Invoice financing acts as a lifeline for businesses in India, transforming unpaid invoices into immediate working capital. This financial tool, available in forms like invoice factoring and discounting, allows companies to enhance liquidity and fuel growth without the wait for customer payments. KredX simplifies this process, making it an accessible option for businesses to manage cash flow effectively. Whether for maintaining operations, investing in growth, or managing expenses, invoice financing is a strategic solution that adapts to the diverse needs of businesses, ensuring financial stability and agility in a dynamic economic landscape.
A. An invoice in finance refers to a document issued by a seller to a buyer, detailing the products or services provided and the amount due for these. In financial terms, an invoice represents an account receivable for the seller, indicating money owed by the buyer. This makes invoices important for cash flow management and credit control in business transactions.
A. Invoice financing in India allows businesses to borrow money against the amounts due from customers. This process involves a financial institution advancing funds to a business based on the unpaid invoices. The financing can be structured as a loan (where the invoice is collateral) or through invoice discounting, where the invoice is sold to the financier at a discount. This provides businesses with immediate working capital, helping to improve cash flow.
A. The two primary types of invoice factoring are:
A. Here, the business retains the risk of non-payment by their customer. If the customer fails to pay the invoice, the business must buy back the invoice from the factor.
A. In this case, the factoring company assumes the risk of non-payment. If the customer doesn’t pay the invoice, the business is not liable to repay the advanced funds to the factoring company.
A. Invoice finance is typically used by businesses that have a business-to-business (B2B) model and issue invoices with payment terms. This includes small and medium-sized enterprises (SMEs), startups, and larger corporations across various industries. Businesses facing cash flow challenges due to delayed payments, or those looking to accelerate growth and need quick access to working capital, can particularly benefit from invoice financing.
A. Invoice financing offers several benefits, including improved cash flow, the ability to manage payment cycles better, reduced need for collateral (as the invoice serves as collateral), and the potential to grow the business without the constraints of slow-paying invoices.
A. Properly managed, invoice financing can indirectly improve a company's credit score by providing the funds needed to pay creditors on time. However, it doesn't directly affect the credit score as it's not typically reported to credit bureaus.