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What is invoice finance and how does it work?

You may have heard of invoice finance and how it can be a great option for businesses looking for some extra cash flow to support growth. In this blog we answer the two big questions: What is invoice finance and how does invoice finance work? 

What is invoice finance?

Invoice finance is the broad term for business finance that lets businesses borrow funds against the value of their unpaid customer invoices. Invoice finance is also commonly known as debtor finance or accounts receivable finance. Because the accounts receivable ledger is used as the main security for the loan, there is no need for business owners to put their home up as security.

Within invoice finance, there are two main types of invoice finance: invoice factoring and invoice discounting.

Invoice factoring

Invoice factoring involves a business selling its invoices to a third-party factoring company at a discount to the full invoice value. As the invoices are sold, the business hands over responsibility for the collection of those invoices. Some business owners like this as it can free up resources to focus on running the business instead of managing accounts receivable collections. The downside to this can be that factoring companies might not manage your customers in the same careful way you would. As your customers are aware that the invoice factoring company is providing invoice finance to the business, this is known as disclosed invoice factoring.

Invoice discounting

Invoice discounting is another type of invoice finance and the main difference to invoice factoring is that, although unpaid customer invoices are used as security for the loan, they are not actually sold to the lender. This means that the business retains control of the accounts receivable ledger and will continue to be responsible for invoice collections. Invoice discounting can be non-disclosed (or confidential) where your customers don’t know that the invoices are being financed; or it can be disclosed to your customers. This really depends on the requirements of the business and the type of invoice discounting service offered by the lender.

Different types of invoice finance

Within invoice factoring and invoice discounting there are also different types of invoice finance that mostly depend on which invoices are financed. 

  • Single invoice finance (or selective invoice finance) is where individual invoices are financed.
  • Partial ledger invoice finance is where invoices with some customers are financed.
  • Full-ledger invoice finance is where the whole ledger is used as security for a loan and can be drawn against. 

Often, partial-ledger invoice finance and full-ledger invoice finance operate as a line-of-credit where the borrower can access funds secured by customer invoices. As the line-of-credit is linked to the value of customer invoices outstanding, the available limit increases as invoices are raised and reduces when they are paid. 

How does invoice finance work?

Businesses can access funds against invoices when they are raised, bringing forward the cash flow rather than having to wait until the invoice is paid. With invoice finance, the loan is repaid when your customer pays the invoice. A lot of businesses prefer this to business loans that have regular weekly repayments that need to be paid regardless of the cash flow situation of the business.

Because customer invoices are used as security for invoice finance, it's important for the lender to have a high level of visibility over those invoices to know that they are legitimate and will be paid by the customer. In the past (and still with some traditional invoice finance providers) it was necessary for borrowers to upload invoices and accounts receivables ledgers which was manual and time-consuming.

Modern invoice finance providers, like Earlypay, integrate with cloud accounting software platforms such as Xero, MYOB and Quickbooks to view invoices in real-time so the lender and the borrower always know the amount of invoices available for finance. Another major benefit of your invoice finance provider's integration with your cloud accounting software is that invoice and loan payment reconciliations are all automated, saving many hours on bookkeeping.

How much finance can I get?

Invoice finance providers typically advance up to 80% of eligible invoices and, when the invoice is paid, the other 20% (less some fees) is paid back to the business or used to pay down the loan balance. Invoices are eligible for finance if they are for goods or services that have been delivered, are with creditworthy business customers and generally are not more than 90 days past the invoice issue date.

Am I eligible for invoice finance?

In addition to having invoices that are eligible for finance, invoice finance providers will also look at the creditworthiness of your business. Lenders have different criteria but they will be similar to Earlypay's requirement that borrowers will need:

  • A valid ACN
  • More than 12 months in business
  • Invoices with other strong Australian businesses
  • Invoices are issued only after goods or services have been delivered
  • At least $500k annual revenue
  • Minimum of three customers (as Earlypay offers partial and full-ledger invoice finance)
  • Integration with Xero, MYOB or Quickbooks

Is invoice finance right for my business?

Generally speaking, it's cheaper to borrow if you can provide some form of security to the lender. This allows the secured lender to charge less than unsecured business loans as it's more likely that the loan will be fully repaid. At the other extreme to unsecured business loans is using real estate security to support your business loan. This will almost always be cheaper than other types of business loans but many business owners do not want to put their home at risk.

In between unsecured business loans and real estate backed loans is asset based finance which uses assets that your business owns as security for the loan. The main examples of asset based finance are invoice finance and equipment finance.

When looking to finance your business, it's best to match your loans with the use of the funds. If you are looking to buy some long-term equipment, an equipment loan that is repaid over the life of the equipment might be best. If you are looking to increase working capital to help your business grow but don't want to use your home as security, then using invoice finance to bring forward cash flow from your outstanding invoices could be the answer. 

By embracing the power of cloud accounting software, modern invoice finance providers like Earlypay are making invoice finance easier than ever before. If you'd like to learn more about invoice finance with Earlypay, please contact our friendly team on 1300 760 205.