What is Invoice Financing? How Does it Work?

Invoice financing is a general term used for asset based lending products that allow companies to finance slow-paying accounts receivable. There are two ways to finance invoices. The first way is through a sale. Invoices can be sold to a factoring company in exchange for an immediate payment. The second way is using receivables to secure a revolving line of credit through an asset based loan.

Although both solutions provide similar results, both methods of financing are very different. This article answers the following questions:

  • What is invoice factoring?
  • How does invoice factoring work?
  • What is an asset based loan?
  • How does an accounts receivable asset based loan work?

What is invoice factoring?

Invoice factoring is a form of invoice financing that allows companies to sell their accounts receivable to improve their working capital. This financing provides the business with immediate funds that can be used to pay for company expenses.

Factoring is easier to get than conventional financing because you are technically selling an asset rather than getting a loan. The most important requirement to qualify is to have invoices from creditworthy commercial clients. As a result, factoring is available to small businesses that don’t have substantial assets or a long credit history.

Generally, invoice factoring is used by companies that have up to three million dollars worth of monthly revenues. Learn more about invoice factoring.

How does factoring work?

Most invoice factoring transactions are structured so that your company sells its invoices in two installment payments. The first installment covers about 80% of the value of your invoices and is deposited to your account within one business day of requesting the funds. Your company gets the remaining 20%, less the finance fee, once the customer pays the invoice in full.

Invoices are usually verified before funding. Verification allows the factor to determine that the invoice is due and that there are no issues that could prevent its payment (e.g., disputes, chargebacks, etc.). Factoring lines are based on your sales. Therefore, lines can increase as your sales to creditworthy commercial clients grow.

Learn more and about factoring and how to select the best factoring company for your business.

What is an asset based loan?

An asset based loan is a form of funding that  allows you to finance most of your company’s asset, such as invoices, inventory, and machinery. It is a form of invoice financing for companies that decide to finance their accounts receivable. An asset based loan is considered an intermediate product between factoring and a bank line of credit.

However, asset based loans differ from factoring in how they operate. They can combine the features of a line of credit or a term loan, depending on which assets are being financed. Asset based loans are available to midsize companies that need a minimum of one million dollars. Learn more about this solution.

How does a receivables-backed asset based loan work?

If the line is used to finance invoices, it works much like a conventional line of credit. This strategy allows your company to draw funds as you invoice clients and pay the line down as customers pay their invoices. On average, lines allow you to borrow up to 80% of the value of your eligible receivables.

To access funds, the client fills out a borrowing certificate. The certificate is used to calculate the borrowing base, which determines how much funds you can get based on your assets. The borrowing certificate lists outstanding receivables (and other assets), subtracts ineligible assets, and applies the resulting amount against your available line.

Learn more about asset based loan structures.

Which solution is the right one for your company?

Which product is best for you depends on the size of your company, its financial strength, and your needs. Factoring can be used by companies of any size – including startups with a limited sales history. Qualifying for factoring is relatively simple and quick. The main requirement is to have unencumbered accounts receivable from creditworthy clients.

Asset based loans, on the other hand, are available to companies that need to finance more than a million dollars of monthly receivables. To qualify, companies must have good financial controls, reasonable financial statements, and assets to leverage. Companies that opt for an asset based loan must go through a financial audit to determine if they qualify. In general, asset based loans are easier to get than bank lines of credit.

Looking for financing?

We are a leading provider of invoice financing. For a factoring or asset based loan quote, fill out this form or call us toll-free at (877) 300 3258.