Key takeaways
- Invoice financing uses your unpaid invoices to get approved for funding.
- Fees can get expensive, sometimes going up each week the client doesn’t pay.
- Factoring is a form of invoice financing that collects payments for you.
- Approvals rely on your clients’ payment history and total unpaid invoices.
If your business gets steady revenue from invoices but doesn’t collect payment right away, invoice financing might be for you. It’s a business loan that can be helpful if you have an emergency expense or need to keep cash flowing.
While you can get this financing with bad credit, you’ll need to show a positive history of client payments to get approved. But this type of financing can get expensive, especially if the financing company raises fees the longer a client doesn’t pay.
Let’s look at invoice financing and what to expect when you apply for it.
What is invoice financing?
Invoice financing is a type of alternative business loan not usually found with traditional banks and credit unions. Also called accounts receivable financing or invoice discounting, it uses your outstanding invoices to secure a loan from the lender.
Since you’ll need outstanding invoices to qualify, this type of financing works well for B2B models with long billing cycles. This includes businesses like warehouses and retail suppliers that may have net-30, -60 or -90 invoices, which means that the invoice is due 30 to 90 days after it’s issued.
Invoice financing is an easier type of loan to qualify for because it considers your clients’ credit and payment history more heavily than your business’s. Many invoice financing companies work with business owners with bad credit, making it an accessible funding option.
Invoice financing vs. factoring
Both invoice financing and invoice factoring secure financing with outstanding invoices. But invoice factoring isn’t a loan. Instead, you sell the invoices to the factoring company.
The factoring company advances cash to your business and typically collects payments directly from customers. For invoice financing, you are responsible for collecting payments from customers.
Invoice factoring can be considered a type of invoice financing, so you may see the terms used interchangeably when referring to factoring.
Bankrate insight
Invoice financing loans typically are offered through online lenders with short terms. For example, you can get this type of financing through SMB Compass with repayment terms of six to 24 months. You can also get invoice financing through lender marketplaces like Lendio and Credibly.
How does invoice financing work?
To get invoice financing, your company will submit its accounts receivables to an invoice financing company. The financing company will review your client’s payment history and approve financing if they deem your client creditworthy.
Once approved, it advances 80 percent to 90 percent of the unpaid invoices, which you can use for any business expenses.
The financing company typically charges borrowing fees. These fees may be called a processing fee, discount rate or factoring rate and are usually a percentage of the invoice amount. Some companies also apply a fee per week that the invoice remains unpaid, such as 1 percent.
Invoice financing example
Let’s say you own a trucking company that delivers supplies to retailers on a net-60 billing cycle. But a slow retail season has left you with $100,000 in unpaid invoices that you need right away. The invoice financing company charges a 0.50 percent discount fee as well as a 1 percent weekly fee. Your invoice financing scenario looks like this:
- You apply for invoice financing. You apply to get financing with $100,000 in unpaid invoices.
- You receive an advance on unpaid invoices. The financing company advances you 80 percent, which comes to $80,000.
- Your clients pay the invoices. Your clients pay you in four weeks, and you’re ready to pay the financing company.
- You pay back the lender with fees. You repay the $80,000 plus the lender’s fees. The lender charges 0.50 percent of the invoice amount and another 1 percent for each week of unpaid invoices. Your total payment looks like:
| Fee structure | Total amount paid |
|---|---|
| 0.50% of $80,000 | $400 |
| 1% x 4 weeks = 4% of 80,000 | $3,200 |
| Total fees | $3,600 |
Factors that influence invoice costs
Your client’s payment history and how much money you need are the main factors that affect financing approvals or lower fees. Let’s look at these factors in detail:
- Total unpaid invoices. Financing companies may look at the total amount of unpaid invoices to evaluate whether they will offer financing. If you only have one or two invoices, you may qualify for spot invoice financing, which lets you choose a few invoices for funding.
- Client’s creditworthiness. The financing company wants to know that the client has a solid payment history and will pay the invoice. It may deny funding if you’re using past-due customer accounts.
- Business revenue. Financing companies may also consider how much business revenue you receive, looking for steady cash flow to show a healthy business.
Pros and cons of invoice financing
Invoice financing helps you use unpaid invoices to secure financing and cover cash flow gaps. But fees easily get expensive compared to conventional business loan interest rates.
Pros of invoice financing
- Doesn’t rely on business credit. Invoice financing companies look closely at your clients’ payment history and pay less attention to your own. That’s because this financing depends on whether your clients will pay.
- No extra collateral needed. You don’t need to secure the financing with other types of collateral or a blanket lien on all business assets.
- Improves cash flow. Invoice financing loans give you access to cash immediately, rather than waiting for invoices to settle.
Cons of invoice financing
- Complicated fees. Rather than using an APR, invoice financing charges either a one-time fee, or the fee may go up each week the client doesn’t pay. This fee structure is confusing to compare with other loan APRs. It also gets expensive, converting to APRs up to 50 percent or more.
- Costly. Depending on the fees and the time it takes to repay, invoice financing can be more expensive than traditional business loans.
- May not cover 100% of unpaid amount. In most cases, you won’t get the full unpaid amount advanced to you. But 80 percent to 90 percent is more capital than you’d have without financing.
Alternatives to invoice financing
Because of potentially high invoice loan fees and the need for creditworthy clients, you may want to look at other business loans if you qualify. Those include:
Conventional business loan
Conventional business loans may offer lower borrowing fees than invoice financing. You can also get longer repayment terms such as five to 10 years, which stretches out repayments and lowers the payment amount. If you don’t have the most ideal credit or payment history, you can find business loans for bad credit borrowers or one that offers relaxed criteria, such as low revenue.
Working capital loan
A working capital loan is typically a short-term loan with a fast-paced repayment schedule, such as weekly payments. While some lenders have a working capital loan specifically, you can use other loans to boost your working capital.
Business line of credit
A business line of credit approves a set amount of funding you can draw from over a period of time. Repayment terms start when you draw funds and are typically short from six to 24 months. It offers payment flexibility because you only draw the amount you need and pay interest on the funds you use.
Business credit card
A business credit card lets you tap credit any time you need it, usually up to a low limit like $50,000. This option works great for small, everyday business expenses. You usually earn rewards like cash back or points redeemable for travel too.
You typically need good credit, such as a FICO score of 670 or higher to qualify. But some cards are designed for borrowers with fair credit.
If you have bad credit, you can use credit-building cards to secure the card with cash. That way, you can start building a positive payment history, but you’re also low risk to the credit card issuer.
Merchant cash advance
A merchant cash advance uses past credit and debit card sales to determine how much financing you can receive. Your business then repays the advance out of a percentage of future sales or as a fixed payment.
MCAs usually charge a factor rate that’s multiplied by the entire amount borrowed. Even a low factor rate can convert into high interest, so consider MCAs as a last resort for funding.
Bottom line
Invoice financing is an alternative type of business loan that helps invoice-based businesses get short-term funding. It focuses on your client’s ability to pay the invoices, so lenders are more willing to work with small business owners who don’t have good credit.
But if you qualify for other types of financing, you should explore those since borrowing costs are likely to be lower with other options.
Frequently asked questions
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