Invoice Financing Guide: What it Is, How it Works & More

It’s common for businesses to struggle with cash flow and working capital because of outstanding debtor invoices. Small businesses in particular are hit hard by slow-paying customers due to tight margins.

Invoice financing is a form of lending that combats this frustrating issue. Business owners who find themselves struggling with long payment terms or slow-paying customers can use this alternative financing solution to quickly increase working capital, improve cash flow, and even reduce collection responsibilities.

This guide breaks down everything you need to know about invoice financing. By the end, you’ll be able to determine whether or not this popular alternative lending solution makes sense for your business.

What Is Invoice Financing?

Invoice financing occurs when businesses sell their outstanding receivables to a third-party company for a cash advance. If you’ve heard of invoice factoring, know that it’s often used interchangeably with invoice financing. Both funding options are forms of asset-based lending. More specifically, invoice-based financing.

When financing invoices, the only collateral is the unpaid invoice itself, and eligibility is dependent on debtors’ creditworthiness, not the borrower’s. These factors can make it a great fit for small business owners who can’t qualify for a more traditional business loan.

What Do Invoice Financing Companies Do?

Invoice financing providers, which typically double as invoice factoring companies, are third-party companies that provide cash upfront to businesses in exchange for their outstanding invoices. This cash advance is usually in the range of 80 to 90% of the total value of each invoice, though exact figures will vary by industry.

But these companies can do much more than just provide an advance—many, such as altLINE, can also assume collection responsibilities.

Two Types of Invoice Financing Companies

Not all invoice financing companies are one and the same; there are two types of providers.

The first is the independent invoice financing provider. These are providers that are unaffiliated with a financial institution, meaning they can draw their funds from any source. Since independent companies have no ties to federally- egulated banks, they can be riskier to work with than the second type of invoice financing company: bank-backed providers.

A bank invoice financing company, such as altLINE, is a branch of a larger financial institution that is dedicated solely to receivables-based lending. An FDIC-insured, federally regulated bank financing company uses its own cash to cover unpaid invoices, meaning there is less risk involved. This highlights the importance of not just picking the first invoice financing company you come across but instead finding a few highly rated providers and comparing your options.

How Does Invoice Financing Work?

The invoice financing process is fairly simple. Like invoice factoring, it involves just a few straightforward steps.

Here’s how the invoice financing process works:

1. An invoice financing agreement is signed between your business and the invoice financing company.
2. When your invoice your debtor, you also forward the invoice to the financing company. They assume responsibility for collections.
3. The invoice financing company immediately advances around 80-90% of the value of the invoice to your business.
4. Your debtor submits payment to the invoice financing company.
5. Any remaining funds are released to your business, minus a small invoice financing fee (typically 0.75-3.50%).

Just like that, your business no longer has to worry about extended payment terms of slow-paying customers hindering cash flow.

Example of Invoice Financing

Below is a scenario detailing how invoice-based financing works. This also exemplifies a situation where it would make sense for a business owner to finance their receivables:

Supreme Staffing is having financial issues. While they have a long list of clients who provide sufficient business, these clients are working on net 30 payment terms, and a few of them often wait until the end of the 30-day period to pay for the staffing services provided to them. Because of this, Supreme Staffing is struggling to pay their employees on time. The business owner, Melissa Johnson, knows that missing payroll is a huge no-no in the staffing industry. Therefore, she turns to invoice financing to improve cash flow and not have to rely on client payment habits to make payroll.

Mrs. Johnson contacts altLINE and asks to learn more about how invoice financing works. Both parties immediately realize that her staffing agency is the perfect fit. A contract is signed, and Mrs. Johnson submits the portion of her ledger whose receivables she wants financed. Moving forward, any time one of these clients is invoiced, she receives an immediate advance of, let’s say, 85% of the invoice value. Once the invoice is paid, the remaining value is released through a secure bank lockbox, minus the small invoice financing fee.

Invoice Financing Requirements

Qualifying for invoice financing is generally significantly easier than traditional funding options. Requirements to apply and get approved for invoice financing are as follows:

• A list of your sales ledger
• Sufficient debtor creditworthiness (your own credit score will not be considered)
• Accounts receivable aging report
• Established operating history, typically at least 1 year

Invoice Financing Costs, Rates, and Fees

The total cost of invoice financing will vary depending on the provider’s rates and fees. But how are exact invoice financing rates and fees determined? There are a few contributing factors:

• Total dollar amount of the financed receivables. Generally, the higher the volume, the lower the fees.
• Creditworthiness and payment history of debtors.
• Industry of the borrowing business. For instance, trucking businesses typically receive advances of up to 99% of each invoice value.
• Percent of your total ledger being financed.

The top financing companies should be completely upfront about their rates and fees. Common invoice financing fees you’ll find include:

• Origination fee: The initial fee charged to process the application and set up your account (typically 0-3% of the credit line). With altLINE, this won’t be charged until after you’ve been funded.
• Early termination fee: Charged when an invoice financing agreement is ended prematurely.
• Monthly minimum volume fee: Only applied when the borrower doesn’t meet the monthly minimum of financed invoices.
• Renewal fees: The annual fee charged that equals a certain percentage of the overall line size.
• Wire fees: If a borrower needs access to funds ASAP, altLINE can issue a wire for $30 per transfer rather than an ACH.

Generally, invoice financing rates and fees will total out to around 0.75% – 3.50% of the value of each invoice. Again, specific figures will vary by the aforementioned factors.

What Are the Benefits of Invoice Financing?

There are many reasons why a business owner would choose invoice-based financing as a go-to funding solution. Some of its advantages include:

Immediate Access to Capital

Most invoice financing companies fund within 24 to 48 hours, meaning you don’t have to wait long to unlock capital. The speed of funding is one of the most notable advantages of invoice financing.

Easy, Quick Approval

Invoice financing is often considered a no-doc business loan, meaning there is minimal paperwork required to apply compared to more traditional funding methods. Plus, there are not many requirements for approval. Perhaps the most inviting aspect of invoice financing for small business owners is the fact that qualification is dependent on your debtors’ credit history, not your own.

Improved Cash Flow

Invoice financing is one of the most commonly used funding solutions for business owners who want to quickly boost cash flow. Not only do you unlock immediate access to funds, but you also don’t incur any additional debt on your list of liabilities. Remember, the only collateral involved is the invoices themselves, so as long as your debtors submit payment, you never have to worry about paying anything back.

Lower Risk Than Most Alternative Lending Solutions

Unlike a few other common alternative lending solutions, there is not much risk involved with financing your invoices.

For instance, a merchant cash advance is often seen as a risky form of financing because payments are based on your future credit or debit sales, meaning if sales slow down, any provided funds will slow down with it. Other asset-based loans might involve jeopardizing hard assets as well, which is not the case with invoice financing.

Types of Businesses That Benefit Most From Invoice Financing with altLINE

If your business fits under any of the following categories, you could be a good fit for invoice financing.

Startups or New Businesses

Obtaining funding for startups can be difficult. First-time startup owners don’t have the business credit history to prove to lenders that they can be reliable borrowers, so they’re forced to find alternative solutions.

Invoice financing is attainable as long as your new business has existing customers on your ledger. Even if cash flow or working capital isn’t a major issue, new business owners can still benefit from invoice financing when scaling their business. It allows entrepreneurs to be able to take on new customers in bulk without having to worry about how to keep up financially with sudden growth in sales.

Small Businesses

Invoice financing is tailored for small businesses. When a company has transformed from a startup to a small business, that generally means sales are on the rise. However, increased sales can create new working capital challenges, particularly if you’re working on long payment terms.

Invoice financing for small businesses is particularly popular because when debtors aren’t paying in a timely fashion, it can affect small business operations much more than it would larger companies due to slimmer margins. Additionally, small businesses might not have the hard assets or credit to qualify for other, more standard forms of business funding, so it’s a perfect alternative.

Seasonal Businesses

Seasonal businesses are always struggling with fluctuating cash flow. When in season, sales are booming and cash flow stays positive. But what about the offseason?

Invoice financing offers stability for seasonal businesses, combating erratic cash flow. It’s generally regarded as the ideal funding option for these types of companies.

Fast-Growth or Expanding Businesses

It’s not uncommon for business owners to actually struggle when their company grows more quickly than expected. For instance, it might be tough to fund extra inventory, afford a new employee, or buy or rent new office space. Even potential new customers might have to be turned away if you can’t afford to fund the completion of their service or product.

This is an unfortunate reality that can be mitigated by choosing invoice financing. By factoring your invoices, you’re maximizing cash flow while minimizing chances of not being able to keep up with sudden growth.

Uses for Your Invoice Financing Cash Advance

Below are some of the most common uses for an invoice financing facility:

Make Payroll

The cash provided from financing invoices can be used to cover one of the most critical expenses for business owners: paying employees.

Making payroll should be a top priority for any employer, especially in certain industries like staffing. This explains why invoice financing for staffing companies has become so popular.

Cover Overhead

Overhead costs are generally hard to predict. When business leaders create their budget, accounting for these costs is challenging, and when they’re high, it can lead to working capital shortages. The quick cash from financing your invoices can ensure overhead doesn’t deter you on your path toward success.

Hire New Employees

When your business grows, the amount of work grows with it. An invoice financing cash advance can stabilize your cash flow so you feel comfortable enough to hire a new employee. Plus, you won’t have to worry about paying that new employee on time moving forward.

Increase Online Marketing Efforts

Business marketing efforts tend to take a backseat to other high-priority internal projects. However, effectively marketing your business can make a major impact if you do it the right way and invest sufficiently. You can use your advance to further increase your company’s online visibility.

Take on New Business

A growing list of customers equates to a growing list of goods or services you need to have in inventory. You don’t want to agree to new business if you aren’t confident in being able to pay your own suppliers on time. Financing your invoices gives you the comfort of knowing you’ll have cash more quickly, so you don’t have to turn away new customers.

What to Know Before Signing an Invoice Financing Agreement

Invoice financing agreements, which look very similar to an invoice factoring agreement, should be carefully examined before signing the dotted line.

Focus on exceptional customer service and look for transparency and honesty when speaking with representatives. Keep in mind that the typical invoice financing contract is one year, but slightly shorter or longer contracts are not uncommon.

When searching for an invoice financing company, it’s best practice to do your research by reading online reviews on websites such as TrustPilot, talking with customer service representatives on the phone, and comparing rates and fees. Remember that partnering with a bank-backed company like altLINE drastically reduces risk by avoiding hidden fees or being locked into a long-term contract.

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