Ever since the Great Recession, the financial market has continually evolved to meet the changing needs of individuals and businesses alike.
Take invoice financing, for example, which is a diverse lending product that enables businesses to leverage their accounts receivable as a way of optimising their real-time cash flow.
We’ll explore the concept of invoice financing below, while discussing its main terminology and the numerous forms that it can take.
What is Invoice Financing?
Invoice financing is actually a generic term, and one that is used for any asset based lending products that cover slow-paying accounts receivable.
While most companies and sectors adhere to 15 or 30-day invoice terms, there are numerous instances in which clients will request 60 or 90-day terms. This can place a significant squeeze on your businesses cash flow and available levels of working capital, making it difficult to take on additional work in the near-term.
Invoice financing can negate this issue, as leveraging your accounts receivable can help you to realise the full value of your invoices almost immediately. There are two ways in which this can be achieved, namely the following:
What is Invoice Discounting?
The first method is referred to as invoice discounting, which is the practice of using your company’s unpaid invoices as the collateral for a loan.
This loan will be extended by a finance company, while the amount of debt issues is typically marginally lower than the value of the outstanding accounts receivable.
In general terms, the debt value will amount to 80% of all invoices that are less than 90 days old, as this helps businesses to recoup a significant sum of money while also allowing lenders to offset their risk.
What is Invoice Factoring?
The second method of invoice financing is known as factoring, and this is arguably the most popular too.
This is a type of debtor finance through which a company sells its accounts receivable to a third party at a slightly discounted rate, usually in a bid to meet immediate and often pressing cash needs.
With this type of financing product, service providers will assume far greater responsibility, as they take on a host of various roles including credit control, sales ledger management and encouraging clients to settle their outstanding invoices.
The Bottom Line
These represent the most prominent forms of invoice financing, and there’s undoubtedly a number of subtle difference between discounting and factoring.
The most obvious of these is that businesses retain control of their accounts receivable and sales ledger in the case of invoice discounting. In contrast, you’ll outsource this responsibility when factoring and move your accounts receivable outside of the business.
Sources: investopedia.com
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