Invoice Financing – Definition, Types and How does it Works

The number of MSMEs recorded in India is nearly 42.5 million, which constitutes about 95% of the country’s industrial unit. Therefore, the government has taken significant strides toward providing credit to this sector to fulfill its aim of making India a $5 trillion economy. It has recently injected the financial institutions and NBFCs with Rs. 70,000 Crore to advance loans with affordable interest rates to entrepreneurs.

Business loans aid the economy of a business with the necessary funds not only for major expenses but for smaller yet essential expenses such as to procure raw materials, maintaining inventory, salary, etc.

There are many circumstances in the business when it requires immediate funding to spread its services in the different parts of the world, it is not only restricted to salary, inventory and other aspects which are responsible for the day to day activities. Another essential service which such institutions provide these days is invoice financing.

What is invoice financing?

Invoice financing is a short-term debt arrangement that helps businesses procure funding from third parties based on trade payables’ invoices. It is also referred to as “trade payable financing.” Debtors constitute a major part of any business due to its instrumental role in working capital. Working capital finance is necessary for small businesses as it comprises of all the expenses involved in daily activities.

Such financing helps businesses to improve their working capital structure and ensure a steadier flow of funds for optimal business operations. It also allays their worry of collating funds from debtors and instead refers to financial institutions for customized financing solutions.

Third parties disburse funds partly, in two installments. The first one involves a bulk payment which is made upfront. It satisfies your business’ working capital needs. The second installment is paid after the third party has collected the outstanding amount from debtors post the deduction of fees.

Types of invoice financing

There are primarily 2 types of invoice financing provided by financial institutions and NBFCs in India.

  1. Invoice factoring: In case of invoice factoring, lenders offer 70% – 85% of the outstanding amount, as is reflected on your invoice, as the first installment. They then set to collect the accrued amount from debtors. If such amount is realized in full by lenders, they pay the remaining part of it to you after deducting their fees. It is a convenient method of realizing debt as it prematurely equips you with the necessary capital.
  2. Invoice discounting: It is an alternative to invoice factoring. In the case of discounting, you need to provide the invoice to the lender, who will advance 95% of the outstanding amount as credit. This credit is forwarded with the condition that it will be your enterprise which will realize the debt and not the lender.

Advantages of invoice financing

This form of credit has gained significant prominence amongst entrepreneurs in recent times. The advantages of invoice financing include –

  1. Immediate finance: When you provide longer repayment tenors to debtors, financing daily activities becomes difficult. In some cases, the time taken for repayment stretches beyond schedule due to some inconvenience on the debtor’s end. The invoice financing facility allows enterprises the leeway to carry their businesses in accordance with their working capital cycle. Therefore, you can enjoy consistency in production and other necessary day-to-day activities.
  2. Assurance of repayment: In case of invoice factoring, there is a greater assurance of repayment compared to when you attempt to redeem the accrued amount yourself. Primarily because financial institutions and NBFCs can dedicate substantial time to acquiring your debt without hindering any necessary activities.

Disadvantages of invoice financing

Invoice financing, however, has a couple of disadvantages to it. These are –

  1. Affects customer relations: Involving a lender for required funding solutions may negatively affect your rapport with other related third parties associated. It can affect your business brand value as well among your customers which may impact in the long run.
  2. Collection: In the case of invoice discounting, although you are disbursed a substantial amount as credit in response to your invoice, you still have to expend your resources to repay.

Therefore, as an alternative, you can also avail of a business loan to finance your working capital. Thereby, you can let the repayment take its own pace and continue with the day-to-day activities of your business.

You can also avail pre-approved offers on such a loan from lenders such as Bajaj Finserv. It makes the process of availing loans easier and simpler. These offers consist of a host of loans such as business loans, home loans, personal loans, etc. You can check your pre-approved offer by providing your name and mobile number.

Invoice financing, however, is a convenient and commonly availed method of infusing additional finance into a business. Substantial working capital helps your business remain agile and aids in the fulfillment of long-term business objectives.