You offered a client say 120 days credit terms, but as you need the cash flow now, you can take the invoice to a factor where they advance e.g. 80% (advance/finance percentage) for your cashflow needs right now.
Used by businesses to improve their cash flow until their customers pay up, invoice financing (Some financiers may also call it Forfaiting) is when a business sells or pledges its accounts receivable or invoices to a Factor (and thus also the name factoring and invoice discounting) at a discount. Traditionally, they are more often used by businesses in trading, exporting, or manufacturing but nowadays, they are also used by those providing services than goods, such as web design or HR as more fintech factoring companies appear.
At times, they may charge you an interest (Discount Rate/Fee) like most loans and that is what they typically earn, apart from fees. However, many Factors in order not to have to fulfil lending laws if any, especially since it may involve multiple countries as even if they just serve the “borrowers” of one country, the borrowers’ invoices may be from a customer of another – they simply buy the invoice from you at a discount of say 80% (advance/finance percentage) and earn the difference instead of charging an interest rate. As a lender may not purchase all the invoices you presented, especially if they are from different customers of yours – on your dashboard it is clearly indicated which are the ones they intend to purchase and you can sell the other to another lender. If you present multiple invoices and say half of it a lender wants to offer 80% and the other at 90%, it will be sending you 2 quotes to your 1 enquiry.
At times, they also allow subsequent invoices presented without having to reassess you again, up to a limit (Advance/Facility Limit), making it similar to an overdraft. But when there is a limit (Advance/Facility Limit) making it similar to an overdraft, the advance/finance percentage then usually becomes a sub-limit, meaning for example, if you have a “line” of $500,000 and you have an invoice of $90,000 which is within the $500,000, they will factor you only 80% of the $90,000 and you can continue to present new invoices later until the limit of $500,000 is hit.
While it is one of the hardest loans to understand because of how many terms there are, used by lenders from various regions, once understood and a business can take advantage of it - it can be extremely helpful for a business, as it can keep on drawing down on it. This is probably the reason why most brokers shun away from even introducing their customers to invoice financing, as it is probably easier to just find another customer that qualifies for working capital loans.
FindTheLoan.com is all about empowering businesses and you, and we will be working with community partners such as Financial Advisors, accountants and CFOs that can help provide more hands-on help on understanding your loan offers and incorporating financial strategies into your business. Please refer to our Community Partners section for more.
On your dashboard, lenders regardless of which region they are from, communicate their offers to you in a common terminology so that it is easy for you to understand and compare. We included terminology from various regions so that should you speak to a lender from another region, you can know if they meant the same thing. Or better yet, have them approach and join us as a Financing Partner if they aren’t already, so you can compare for the best offers all in one place.
For projects that have milestone payments, unless you are factoring and issuing an invoice for each milestone completed, they are financing you based on the incomplete project in advance and thus is also called project financing/contract financing. Unless you and/or your customer have significant financial strength and/or along with credit insurance. Lenders typically prefer to consider just invoice financing with is more temporary.
At times, fulfilling an invoice requires you to have substantial finance to fund raw materials or inventories. Purchase Order finance, also known as PO financing, supplier financing, and reverse factoring, provides dedicated funding for businesses to pay only specified suppliers. Think overdraft but with a limited range of usage.
Technically a purchase order is sent by buyers to vendors to track purchasing process and inventory, while an invoice is an official payment request sent by vendors to buyers once their order is fulfilled, however, some businesses may use the term interchangeably. So, it is simpler to just understand if you need financing to pay your supplier (PO) or if you want to advance cash flow from outstanding payments of your customers (invoice).
Trade finance or import/export finance is yet another term that you may often hear along with the above. Sometimes they are used interchangeably, but most would tell you it is not a loan type but a range of services where they are also responsible for collecting the shipping documents and ensuring the payment to the exporter among other things.
Note: Many small businesses write “cash upon delivery” or “upon completion” as some of their large clients pay as and when they want to. However, you should still state a payment due date in your invoice even if you do not exact a late fee on your client. This is because the factor bases the tenure of the “loan” on the invoice’s credit term e.g. 120 days (to client) + 30 days (grace), meaning you have 150 days in total to repay the factor. Without it they may not be willing to consider taking in your invoice as it may have to be considered as a loan among other things.
If it is a progressive payment based on the completion of certain deliverables, make sure they are stated clearly as well, even if they are estimated dates/days. If they were stated separately via a contract, always include them as supporting documents to prevent delays with your application.
SMEs seeking financing frequently face delays due to the unstandardized format of their invoice. Therefore, it can be helpful to invest some time to look for a suitable template online. You may also find it helpful to read our articles on Fees and Interest calculation.