Invoice Financing Guide: How it Works

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Invoice Financing Guide: How it Works

Cash flow management is a critical component of any business’s survival. One of the key elements of cash flow is managing your small or medium business accounts receivables. Unfortunately, not every customer will pay on or before the due date. Also, some business expenses may arise before the projected due dates of the outstanding invoices. This will, of course, strain your business’s cash flows.

This is where invoice financing comes in. It allows a business to sell its accounts receivable or borrow money from third parties against the due customer amounts. The whole process operates on leveraging the unpaid invoices, that’s accounts receivables for short-term financing to help manage your small business’s cash flows.

Types of Invoice Financing

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Invoice Factoring

It involves selling your accounts receivables or unpaid invoices to a financing firm, usually a bank or a factoring firm. The sale is generally at a discount, so you will receive less than the total invoice amount.

Some factoring companies extend up to 70% to 80% of the invoice amount upfront. When your customer finally settles the outstanding invoice, the factoring company will pay you the rest of the money, less their fee. One important thing to note about invoice factoring is that the financier, i.e., the factoring company, will be in charge of collecting the customer’s debt.

Invoice factoring can also be recourse or non-recourse. If it’s a recourse, your business will bear the invoice’s costs if the customer fails to pay, while in non-recourse, the factoring company assumes the costs of the bad debt. Due to this, non-recourse factoring invoices are rarely and more costly.

Invoice Discounting

With discounting, you are still in charge of the sales ledger and collecting the customer’s due invoices. The financing firm only offers you about 70% to 80% of the invoice amount upfront. When your customers pay, you pay back the credit extended plus a fee.

The below table shows the differences between invoice factoring and discounting:

Invoice Discounting	Invoice Factoring
The business still retains control over its sales ledger.	The factoring firm takes control of the sales ledger of the business.
Offers confidentiality since the business is still in charge of collecting on due invoices.	Lacks confidentiality because the factoring company takes on collecting responsibility when the invoice is due.
The customer pays the invoice amount directly to the business.	The customer pays the factoring firm the money.
One can use a selection or whole invoices against one or multiple invoices, respectively.	Factoring is best for the one-off financing of individual invoices.

Pros of Invoice Financing

It offers quick access to cash to companies for liquidity purposes
It is easy to access funds compared to traditional lending products from banks
Requires no property as collateral

Cons of Invoice Financing

The fees can be costly.
Lack of confidentiality, especially with invoice factoring.
Loss of sales ledger control if you use invoice factoring.
Some financing firms might require a specified contract length.
Your business requires an established and strong credit collection team and process to ensure due invoices are paid on time. This will help in reducing the over-reliance on invoice financing for cash flow management.

Invoice Financing in Kenya

Several firms in Kenya offer this service, including non-traditional banks. Some banks are grouping invoice financing under trade financing, so you might have to check that whole section.

However, I have noted that most firms offer invoice discounting of up to 80% of the invoice amount. Also, most of the firms do not provide discount fees on their sites, which is inconvenient if you are looking for information online.

That said, some of the basic requirements I have seen across the board include;

A valid trading license or business permit
Invoice/s acknowledged by both parties (buyer and seller)
Delivery notes acknowledged by both parties (buyer and seller)
Certificate of completion if there is any
Bank statements if the financier is not your banker

Final Word

If you are sitting on some sizable amount from your accounts receivables and in need of cash to run your business, you can consider financing using those invoices. It could be a little costly, but it will provide you with the quick money needed to manage your business expenses.