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The Merchant’s Guide to Invoice Financing

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Every business struggles with cash flow, but it’s safe to say that businesses that process invoices struggle more than most. Companies purchasing goods or services from B2B businesses have special privileges that customers don’t. Namely, customers have to pony up the money up front to get the goods, but companies get extra time to pay.

If you’re a business owner that uses invoices, waiting around for your customers to pay up can be a huge drag on your resources. And these days, companies are taking longer than ever to do just that.

Fortunately, somebody solved the invoice problem a long time ago. Invoice financing (also called accounts receivable financing or a/r financing) helps you turn your unpaid invoices into immediate working capital, either by selling your invoices or using them as collateral.

In the past, certain forms of invoice financing, such as invoice factoring, have gotten a bad rap due to shady marketing tactics and ridiculous contracts. On top of that, invoice financing is a broad and confusing category with many financing options. The rise of marketplace loans and their non-traditional financing options have made understanding what you’re getting yourself into even more difficult.

So let’s make it easier. Here’s everything you need to know before embarking on your quest to use invoice financing for your business.

Traditional Invoice Factoring

The most basic form of invoice factoring works something like this:

  • You sell your business’s invoices to a factoring company
  • The factoring company gives you 85% – 95% of the value of the invoice up-front
  • The customer’s payment is collected by the factoring company
  • The company gives you the remaining 5% – 15% minus fees

Obviously, the situation is not ideal. Nobody wants to give up a percentage of their revenue. From a business standpoint, though, immediate access to revenue gives you the ability to put that capital to use paying employees, purchasing new materials, goods, equipment, advertising, or doing whatever you need to grow your business.

While it is possible to find reputable factoring companies, many merchants find the terms disagreeable. It’s common for factoring companies to require long-term contracts in which you have to sell all your invoices (or all from specific customers). They also charge extra fees, such as monthly minimums and bank wire/ACH transfer fees. This is why it’s important to find a transparent factoring company with terms that work for your business.

Here are common variations on traditional factoring that you should be aware of:

Recourse vs. Non-Recourse Factoring

The majority of factoring deals are recourse factoring deals, which means that if the customer doesn’t pay, the business owner is responsible for the unpaid invoice.

Because the factoring companies are actually purchasing your invoices, it is possible to get a non-recourse deal. As you’d expect, this means that you’re not responsible for the unpaid invoice if the customer doesn’t pay. These deals normally come with higher fees.

Invoice Discounting

This is also known as confidential factoring or non-notification factoring. Basically, it’s the same as invoice factoring, but the unpaid invoices are not purchased by the discounting company. Instead, the invoices are simply used as collateral.

The advantage of this type of financing is that the customer doesn’t know you’re using their invoices as collateral. The discounting company will do this by setting up a lock box account under the your name, but which the company still has access to. This way it can collect the invoice payments while you maintain a more personal relationship with your customers.

Online Invoice Financing

Online lending has exploded in an array of non-traditional financing methods over the past decade or so. A few of these new companies have taken on the task of updating invoice financing.

These companies have made the invoice financing process easier in a number of different ways. Their applications processes are completely online, they don’t require long-term contracts to use their services, they don’t charge extra fees, and you are in control over which invoices you choose to finance.

Aside from those characteristics, the companies are so diverse that you’ll have to investigate them individually to decide which is right for you. Here are Merchant Maverick’s favorite marketplace invoice financing options:

The Bottom Line

At its core, invoice financing is a simple concept: it’s a way for businesses to smooth out their cash flow. The agreement doesn’t have to be complicated. When you’re looking for an invoice financing partner, find one that works on your terms. If you need to keep the arrangement discreet, find a funder who is willing to honor that. If you only need to redeem an invoice occasionally, find a funder who is more lenient.

Merchants who are looking for a way to smooth out cash flow without bringing invoices into the mix could consider getting a line of credit.

Chelsea Krause

Chelsea Krause

Managing Editor - Accounting
Chelsea Krause is a writer who has specialized in accounting for two years and is a QuickBooks Certified User. She has a BA in English & Creative Writing from George Fox University and studied at the University of Oxford as well. She has been quoted in Forbes and her work appears in Startup Nation, Small Business Bonfire, and Women on Business.
Chelsea Krause
Chelsea Krause

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    What’s great about invoice financing is that it, like you said, does not have to be difficult. Thanks for sharing the tips!

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