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Invoice factoring is a form of business financing, in which a business sells its accounts receivable (i.e., invoices) to a third party (called a factor) at a discount. Accounts receivable financing provides an advance on payments for outstanding invoices. This way, you can have working capital to reinvest in operations and growth sooner than you could if you waited for your customers to pay you.
How Does Invoice Financing Work?
Invoice financing can be explained in five simple steps:
- You provide the goods/services to your customer and invoice them.
- You send the invoice details to the invoice finance provider.
- A certain percentage of the face value of the invoice is made available to you.
- Either your own credit controller or the invoice finance provider’s sales ledger service carries out the invoice collection procedure.
- When your customer pays the invoice, the rest of the value of the invoice is made available to you — minus a service fee.
Invoice Factoring vs. Invoice Discounting
Invoice finance can be set up in a few different ways, and this is often done by invoice factoring or invoice discounting.
With invoice factoring, the company that needs funding sells outstanding invoices to an invoice finance provider, who pays the company a majority percentage (70 – 85% for example) of what the invoices are worth up front. When the invoice finance provider receives the entire payment for the invoices, it will then send the remaining percentage of the invoice amounts to the business, and the business will pay interest and/or fees for the service. The business’s customers will be aware of this arrangement, however, which runs the risk that it will reflect poorly on the business.
Another form of invoice financing is invoice discounting. Invoice discounting is similar to invoice factoring except that the business — not the invoice finance provider — collects payment from customers, so customers are not aware of the business’s arrangement with the invoice finance provider. Invoice finance providers typically advance businesses up to 95% of the invoice amount with invoice discounting. When customers pay their invoices, the business repays the invoice finance provider, minus a fee.