What is Invoice Financing and How Does It Work?

Invoice financing is a general term used for receivables based lending products. It allows you to advance funds that are tied up in your outstanding invoices. Rather than having to wait thirty, sixty, ninety days to be paid – or even longer – the money can be in your account in twenty-four hours.

What Is Invoice Financing?

There are two variations of invoice financing, these are called invoice factoring and invoice discounting. These terms will often be preceded by the word ‘confidential’ or ‘disclosed’ – for example, confidential invoice discounting. At the risk of stating the obvious, this dictates whether your customers are made aware that you are using an invoice financing company. If it is disclosed, the factoring company will not hide their identity; if it is confidential, they will purport to be part of your business – don’t worry if this sounds a bit cloak and dagger, it’s all above board.

How Does Invoice Finance Work?

Invoice factoring is more hands-on, it involves more work for the factoring company and less work for you. The main distinction between invoice factoring and invoice discounting is that with the former, the credit control is done by the factoring company. This means that they would call your customers and request that payment is made when an invoice is due. Additionally, they would run a shadow ledger which sounds spooky but simply means they mirror your sales ledger – adding invoices as you issue them and allocating payments as your customers settle invoices.

Invoice factoring essentially allows you to outsource your credit control, which can be really handy if it isn’t cost effective for you to employ someone to do it. Alternatively, if you – as the business owner or director – are spending your precious time chasing invoices then you can outsource this task and free yourself up to focus on more important things.

At the other end of the spectrum, invoice discounting is a funds only arrangement. Because of this, there is an implied level of trust between the invoice discounting company and you. Most companies would like this option because it’s less intrusive but not all will qualify for it. To be eligible for invoice discounting, you would generally need to be a company which is established, profitable and able to demonstrate that you can operate said facility. There is a lot more work involved for you with this type of funding. Firstly, you are responsible for contacting your customers and collecting payment for outstanding invoices. Secondly, it’s up to you to take care of the admin and make sure your account is up to date. This involves completing a month-end reconciliation which requires you to compile a report that informs your invoice discounting company about the movements on your sales ledger as they don’t run a shadow ledger.

So, you might be thinking it sounds great but how does invoice finance work? Let us try to explain. As usual, you complete your job and take great pride in issuing an invoice to your customer. You should also notify your invoice financing company about the invoice. Generally, within 24 hours they will advance a percentage of the invoice (usually around 85%) and the money will be in your account rather than waiting to get paid.

Then, as the invoice falls due, either you or your invoice factoring company will contact your customer to collect payment. As per the details on your invoice, your customer will make payment to a bank account operated by your invoice finance company. They will use the funds to repay themselves and then make the remaining balance available to you – and the whole cycle starts again.

Invoice financing is for companies that are selling business to business on credit terms and issuing invoices after the job is complete. A caveat to this is businesses in the construction sector who often issue valuations and applications for payment at agreed stages throughout a project – if this sounds like your business you can still use invoice financing but there is a specialist construction finance service that has been tailored for you.

If you’re new to invoice financing and want to boost your cashflow, we can help. If you’re already using an invoice financing company and want to see if there’s a better offer or service out there then we can help with that too. Contact the invoice finance experts at Ping Finance today.

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