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When Does Invoice Financing Make Sense?

Let's learn more about invoice financing, discuss your options, and see why it's so important.


If customers habitually pay off your invoices later than you want, you could very well end up with a serious cash flow problem on your hands. According to a study led by U.S. Bank, 82 percent of startup and small business failures can be traced back to cash flow mismanagement.


There are a few different ways you could approach a late-paying customer, but if these methods don't succeed-or if you don't have the time or energy to chase down your outstanding payments-then invoice financing could be your solution.


Let's learn more about invoice financing, discuss your options, and see why it's so important.


What is invoice financing?


Invoice financing, also known as accounts receivable financing, is a type of business loan that takes your outstanding invoices as collateral.


In other words, it's a loan backed by the invoices your customers haven't paid off yet. When you work with an invoice financing company, they'll typically advance you around 85 percent of the outstanding invoices you've selected, and then pay you most of the other 15 percent when the invoice gets paid off.


With invoice financing, you're essentially paying fees-generally a static three percent processing fee and then a smaller "factor fee" that depends on how late your invoices get paid-to get cash now instead of sometime down the road.


You're receiving less money from your customer, but you're getting the capital when your business needs it: right away.


Types of invoice financing:


That being said, there are a few other models of invoice financing to be aware of. First of all, not all invoice financing companies operate on the 85/15 split.


Instead, some will advance you the entire amount for the invoices you select and simply charge interest on those funds-similar to how a line of credit works. Again, you're paying extra (or receiving less) for the option to get paid right away.


Then, other lenders will offer you the total amount of your outstanding invoices, on the condition that you pay them back on a weekly basis-usually for 12 weeks-until the advance gets repaid.


Invoice financing compared with invoice factoring:


With financing, you still own the invoices-you're just receiving advances and paying fees for them. But with factoring, a lender will actually buy that debt, taking on responsibility for the invoices entirely.


On the one hand, you won't have to wait on the customer at all. But on the other, these lenders will then sometimes collect on those invoices from your customers directly, which might not be the best experience.


Should you consider invoice financing?


Invoice financing can be useful in plenty of different situations:


  • You need extra cash right away
  • You're relying on a few large payments
  • Customers regularly pay late

But there's one big problem that invoice financing can solve especially well:


If those late-paying customers are hurting your cash flow, you should consider financing their invoices.


Studies show that the total amount of late payments has increased in the United States-and B2B businesses are especially hard-hit. In fact, over 42 percent of B2B invoices were paid late in 2014, and that trend is set to continue.


The effect of unpaid invoices


Certain industries feel the effects of late payments more than others: electronics, food service, creative freelancers, and especially construction businesses suffer from slower cash flow because of late payments.


Unfortunately, clients and customers haven't only been paying their invoices late because of laziness or forgetfulness. Many large companies have actually been demanding longer payment terms from their small business suppliers, some as long as 90 or 120 days. They have the bargaining power, and these small business owners have nowhere to turn.


According to V. G. Narayanan, Harvard Business School's accounting practice unit chief, this practice will quickly raise prices for everyday consumers in addition to potentially pushing certain suppliers out of business because of cash flow issues.


Ultimately, unpaid outstanding invoices can bring down a small business.


But with invoice financing, you don't have to rely on your customer's schedule or bad habits-and you can more easily weather the storm caused by these big firms holding out on paying.


Cash flow is king-it's a law of business.


So, if your late-paying customers are harming your cash flow to the point where you're struggling to afford the next project, pay your employees, or keep the lights on, you know it's time to seek out financing.


There are other options, especially if you're only dealing with a few late invoices-like resending the payment request or hiring a collections agency-but invoice financing can help to keep you on your feet when you need it most.



- Merideth Wood is the Editor-in-Chief at Fundera, a resident Finance Advisor on American Express OPEN Forum and an avid business writer.