Everything you need to know about invoice financing

Invoice financing is a popular funding option for businesses globally. With invoice financing, companies can access cash that would otherwise be tied up in unpaid invoices. This trade finance solution can be an effective way to solve cash flow problems, pay staff and grow a business.

What is invoice financing?

Invoice financing - also known as 'invoice factoring' or 'accounts receivable financing' - is a collective term for financing based on outstanding invoices. Invoice financing allows Suppliers (Exporters) to improve cash flow by receiving advances from a third-party finance provider against unpaid invoices.

The invoice factoring company pays the Supplier an initial amount of the outstanding invoice and may also, depending on the type of factoring used, chase the Buyer (Importer) for payment when the invoice falls due. Once the invoice is settled in full, the factor passes the remaining balance to the Supplier, minus a small fee.

Invoice financing is requested predominantly by Suppliers but Buyers can also arrange a service known as reverse factoring, which is explained below.

Invoice financing process explained

1. A Supplier invoices a Buyer for products or services with payment terms of, for example, 120 days.
2. The Supplier needs cash now, so applies for invoice financing with a factoring company.
3. The factoring company approves the application and pays 90% of the outstanding invoice amount directly to the Supplier.
4. The invoice factoring company later receives the full invoice amount from the Buyer on the invoice due date.
5. The financier then pays the remaining 10% (minus a pre-agreed service fee) to the Supplier.

Example of invoice financing

Exporter Ltd is owed £10 000 (GBP) by Importer Ltd after invoicing it for payment with 90-day terms. However, Exporter Ltd needs cash now, so it sells the invoice to an invoice financing company (Stenn).

Stenn pays 90% of the invoice value (£9 000 (GBP)) to Exporter Ltd within 48 hours of the relevant signed documents being approved. Stenn now owns the invoice, including the responsibility for chasing Importer Ltd for payment. 

When Importer Ltd pays the £10 000 (GBP) invoice amount to Stenn, Stenn pays the remaining £1 000 (GBP) to Exporter Ltd, minus a pre-agreed fee. In this case, Stenn also offers non-payment protection, so Exporter Ltd will not have to refund any money if Importer Ltd doesn't pay.

Who uses invoice financing?

Invoice factoring is incredibly accessible. Businesses of any size can benefit from invoice financing but the service is common in international trade where companies expanding into global markets are cautious about new Buyers that demand deferred payment terms for goods and services.

Is invoice discounting the same as invoice financing?

Invoice discounting - or 'recourse financing' - is a specific type of invoice financing with one key difference.

With invoice discounting, the Supplier receives a cash advance for the invoice but retains responsibility for chasing the Buyer for payment. The Supplier has no protection against non-payment from the Buyer. 

The financing process is the same, with the financier claiming a service fee when the invoice is settled. However, the Supplier will be responsible for reimbursing the finance provider should the Buyer not pay. 

Different types of invoice financing

Recourse financing: As mentioned above, this is where the Supplier carries the risk for payments from its Buyers. The Supplier is liable for payment to the financier if the Buyer doesn't pay. 

Non-recourse financing: In this case, the finance provider assumes the entire risk for non-payment from the Buyer. If the Buyer doesn't pay, the financier will face a loss and will try to recoup that loss from the Buyer through legal means. 

Domestic and cross-border financing: Domestic financing refers to deals with all parties in the same territory. Cross-border financing describes an agreement where the Supplier and Buyer operate in different international markets. Cross-border factoring financing fuels a large part of international trade.

Disclosed and undisclosed financing: These types of financing refer to whether or not the Buyer knows that the Supplier is using an invoice factoring company. 

Is invoice factoring better than a loan?

Invoice financing is often preferred to a bank loan. Bank financing solutions have strict requirements and regulations to adhere to, with large amounts of paperwork to complete, making the loan process complex and time-consuming. Also, there is no guarantee the loan will be approved. 

With invoice factoring, however, the decision-making process is fast and straightforward and applications are approved or declined within days or weeks rather than months.

Furthermore, with invoice finance there are no long-term repayment schedules and no risk of damage to an Exporter's credit rating, unlike business loans. 

In summary, small businesses are more likely to qualify for invoice financing than a bank loan. Banks are increasingly reluctant to risk lending to small companies, especially those involved in international trade. 

Invoice factoring - advantages and disadvantages

It's crucial to understand the pros and cons of invoice financing compared with alternative financing options.

The advantages of invoice financing

• Instant cash flow - some factoring companies can deposit funds within 48 hours of approval, meaning SMEs can be paid soon after the invoice has been issued rather than waiting for payment from the Buyer.
• No collateral needed - the invoice finance loan uses the invoice itself as collateral and thus is not a risk to any other business assets.
• Greater chance of approval - banks are unwilling to lend money to small companies involved in international trade as the risk of non-payment is higher. Invoice factoring companies advance funds against individual invoices based on the Buyer's creditworthiness, so applicants are much more likely to be approved for financing.
• No need to chase the Buyer - if the Exporter applies for non-recourse financing, the financier will own the invoice, chase late payment and suffer the loss if the invoice isn't paid.
• Opens growth opportunities - invoice financing gives growing SMEs upfront cash to invest and grow rather than suffer the cash flow problems caused by delayed invoice payments.

The disadvantages of invoice financing

• Invoice financing costs - factoring companies charge a service fee, usually a percentage of the factored amount.

• Must be a B2B relationship - invoice finance cannot be granted for anything other than invoices sent to other businesses.

• Reputation - with non-recourse invoice factoring, the financier collects invoice payments from the Supplier's customer. Therefore, the Buyer will learn that the Supplier is using a finance provider, something the Supplier may wish to keep secret.

• Liability - with recourse invoice factoring, the Supplier is responsible for full payment if the Buyer doesn't pay.

If you are interested in learning more about the content listed above, Stenn has a dedicated FAQ section where you can find more information about our invoice financing services. We also provide videos which explain the company and the financing process in detail.

About the Authors

This article is authored by the Stenn research team and is part of our educational series.

Stenn is the largest and fastest-growing online platform for financing small and medium-sized businesses engaged in international trade. It is based in London, provides financing services in 74 countries and is backed by financial giants like HSBC, Barclays, Natixis and many others.

Stenn provides liquid cash to SMEs within the global financial system. On stenn.com you can apply online for financing and trade credit protection from $10 000 to $10 million (USD). Only two documents are required. No collateral is needed and funds are transferred within 48 hours of approval.

Check the financing limit available on your deal or go straight to Stenn's easy online application form.

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Disclaimer: The above article has been prepared on the basis of Stenn's understanding of the subject. It is for information only and doesn't constitute advice or recommendation. Whilst every care has been taken in preparing this article, we cannot guarantee that inaccuracies will not occur. Stenn International Ltd. will not be held responsible for any loss, damage or inconvenience caused as a result of anything published above. All those applying for credit should seek professional advice when doing so.