Invoice Financing: Definition and How It Works
Invoice financing can be a good funding option for business-to-business, or B2B, companies with cash tied up in unpaid invoices.
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Managing Editor Invoice financing, at a glance
- Maximum advance amount: Up to 90% of invoice value.
- Repayment term: Until the customer pays the invoice (usually one to three months).
- Fees: 1% to 5% of the invoice value.
- Funding speed: As fast as one day.
Late-paying customers can disrupt your small business’s cash flow. If you’re waiting on unpaid invoices, but need working capital now, invoice financing lets you turn those receivables into immediate funding.
What is invoice financing?
Invoice financing is a type of business financing that functions as a cash advance on outstanding customer invoices. It allows small-business owners to use invoices as a form of collateral to secure a loan or line of credit.
This type of business loan can help you account for gaps in cash flow in order to purchase inventory, pay employees and, ultimately, grow faster.
Because your invoices serve as collateral, invoice financing can be easier to qualify for than other small-business loans, although borrowing costs can be higher. You still own the unpaid invoices and remain responsible for collecting payment on them.
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With invoice financing, lenders advance a percentage of your unpaid invoice amount — potentially as much as 90%. When your customer pays the invoice, you'll pay the lender back the amount loaned plus fees and interest.
How invoice financing works
Step 1 You submit an invoice to your lender.
Step 2 The lender advances you funds.
Step 3 You collect payment from your customer.
Step 4 You repay the lender, with fees.
Invoice financing example
Here’s a more detailed example explaining how invoice financing works:
- Invoice is submitted. Let’s say you’re going to finance a $100,000 invoice with 30-day terms. You submit this invoice to a lender.
- Funding is received. The financing company approves your invoice submission and gives you an advance of 90% ($90,000).
- Fees are charged and you collect payment. The company charges a 2% fee for each week it takes your customer to pay the invoice. The customer pays in two weeks, so you owe the lender a $4,000 fee — 2% of the total invoice amount of $100,000 ($2,000) for each week.
- You repay the lender. After the customer pays the invoice, you’ll keep $6,000 and send $94,000 (the original advance amount, plus fees) to the lender. You’ve paid $4,000 in fees, which calculates to an approximate APR of 53%.
How much does invoice financing cost?
Invoice financing can provide fast access to cash, but it can also be expensive. Costs will vary based on the structure of your loan, size of your request and the payment speed of your customer.
Here’s how pricing typically works:
Weekly factor fee
This is the most common pricing structure. The lender advances a percentage of your invoice value and charges a weekly fee until your customer pays.
Typical range: 0.5% to 2% per week.
Example:
- Invoice amount: $50,000.
- Advance: 90% ($45,000).
- Weekly fee: 1%.
- Customer pays in six weeks.
The cost equals 6% of the invoice value, $3,000. Keep in mind: A 1% weekly fee sounds small, but it can quickly add up over time.
Monthly fee
Some lenders charge a monthly rate instead of weekly.
Typical range: 1% to 5% per month.
Example:
- $50,000 invoice.
- 3% monthly fee.
- Customer pays in two months.
The cost equals 6% of the invoice value, $3,000. This model can become expensive if customers regularly pay late.
Interest plus platform fee
Some lenders may structure invoice financing more like a traditional loan:
- Interest rate, often between 10% and 40%.
- Plus a platform, origination or service fee (typically 1% to 5%).
This model can be easier to compare to other financing products because it uses a traditional interest rate. You’ll need to check, however, whether additional fees are rolled in or charged separately.
How to estimate the effective APR
Because many invoice financing companies quote weekly or monthly fees instead of APR, it’s important to understand the true annual cost.
You can make an estimate using this formula: Effective APR ≈ (Total fees ÷ Advance amount) × (365 ÷ Days outstanding)
For example:
- Invoice: $50,000.
- Advance: $45,000.
- Weekly fee: 1%.
- Paid in 4 weeks (28 days).
- Total fee: 4% of invoice = $2,000.
Effective APR ≈ ($2,000 ÷ $45,000) × (365 ÷ 28)
≈ 0.044 × 13.04
≈ 57% APR
Even though it only took the customer four weeks to pay, the APR is high.
In the same example, if it takes the customer eight weeks to pay (instead of four), the total fee is $4,000. The APR is about 58%.
Take note: The APR remains similar (and is still high), but the dollar cost keeps rising the longer it takes your customer to pay.
Additional fees to look out for
Some financing companies charge additional fees on top of their stated rate. These fees can increase your total cost. Keep an eye out for:
- Origination or processing fees.
- Monthly minimum volume requirements.
- Monthly account maintenance fees.
- Wire or ACH transfer fees.
- Renewal fees.
- Early termination fees.
- Credit check or due diligence fees.
You should always get a full fee schedule in writing before signing any agreement.
Types of invoice financing
Invoice financing can be used as a catch-all term, but it can refer to several different products. Here’s what each term usually means.
Invoice financing vs. invoice factoring
Invoice financing (also called accounts receivable financing)
- You use your invoices as collateral for a loan or line of credit.
- You retain ownership of the invoices.
- You collect payment from your customers.
- You repay the lender once the invoice is paid.
Invoice factoring
- You sell your invoices to a factoring company at a discount.
- The factoring company advances you a portion of the invoice’s value.
- The company collects payment directly from your customer.
- You receive the remaining balance, minus fees, after payment is collected.
Invoice financing is usually a better option for businesses that want to maintain control over invoices and deal with their customers directly. Invoice factoring, on the other hand, can be a better solution if you don’t mind giving up control of invoices and you trust the factoring company to be respectful and professional when dealing with your customers.
Invoice discounting (confidential vs. disclosed)
Invoice discounting is a type of invoice financing where you borrow against your invoices, typically without your customers knowing.
Confidential invoice discounting
- Your customers are not notified.
- You manage collections.
Disclosed invoice discounting
- Your customers are notified.
- They may pay into a lender-controlled account.
- You may still handle communications.
Selective (spot) financing vs. whole-ledger financing
Selective financing
With selective, or spot financing, you choose which of your invoices to finance and there’s no long-term commitment required by your financing company.
Whole-ledger financing
You commit to financing all (or most) of your invoices for a specific period.
Spot financing is a more flexible option, but may have higher rates. Whole-ledger financing, on the other hand, may have lower rates, but you’ll need to meet the minimum volume requirements set by your lender.
Accounts receivable line of credit (A/R line of credit)
An accounts receivable line of credit is a credit line secured by your accounts receivable. You can draw on the line as needed, but your borrowing limit is tied to the value of your eligible invoices.
An A/R line of credit offers more flexibility than traditional invoice financing and can be a good option for ongoing working capital needs.
Pros and cons of invoice financing
Pros
- Ideal for business-to-business companies and seasonal operations. Invoice financing works best for businesses that primarily deal with other businesses since outstanding invoices are necessary to obtain funding. Invoice financing can help these types of businesses alleviate cash flow issues due to unpaid invoices.
- Invoices serve as collateral. Because invoice financing is backed by your invoices, it can be easier to qualify for compared to other types of business loans. Lenders typically consider your customers’ payment history when evaluating applications, meaning you may still be able to qualify if you’re a startup or have bad credit.
- Fast to fund. Invoice financing companies usually offer simple applications with minimal documentation and can sometimes provide funding in as little as 24 hours. The quick financing process can be especially advantageous when you're facing cash flow issues or an emergency.
Cons
- Can be expensive. The fees on invoice financing may seem competitive at first look, but when you convert them into an APR, rates may be as high as 79%. That’s much more than SBA loans, for instance, in which APRs currently range from 9.75% to 14.75%.
- Reliance on customer payments. The amount you pay in fees is based on how long it takes your customer to pay the invoice, meaning it’s difficult to estimate the total cost of invoice financing upfront. If your customer is late or misses a payment, an invoice financing company may charge late or additional fees. You face bigger risks if your customer doesn’t make payments altogether.
- Limited to B2B businesses. Direct-to-consumer businesses will be much more unlikely to access this type of financing, as they typically require immediate payments for services or products.
How to get invoice financing
1. Understand what you need to qualify for invoice financing
To qualify for invoice financing, you’ll need:
- Unpaid B2B invoices for completed work.
- Creditworthy customers who have a history of paying on time.
- No liens on receivables (i.e. your accounts receivables cannot be pledged as collateral on another loan).
In general, the creditworthiness and reputation of your customers play the largest role in the underwriting process, making it easier to qualify for invoice financing over other business loan options.
Nevertheless, most lenders will consider standard business loan criteria, such as your personal credit score, time in business and business finances as well. Plus, the stronger your qualifications, the more likely you are to access the largest loan amounts and most competitive fees.
2. Choose an invoice financing company
Invoice financing is usually offered by online lenders and fintech companies. Compared to other types of business loans, banks are less likely to provide invoice financing.
Some examples of invoice financing lenders include:
- Upwise Capital. This lender offers fast invoice financing that’s accessible to a wide variety of businesses. You can finance up to 100% of your invoice amount and interest rates typically range from 8% to 30%. Upwise accepts borrowers who have at least one year in business, annual revenue of $150,000 or more and a personal credit score of 600 or higher.
- Porter Capital. Porter Capital is an Alabama-based lending company that specializes in different kinds of loan products for small businesses across the U.S., including accounts receivable financing. Rates vary depending on other qualifying factors, but businesses can apply online and expect a decision within 24 hours.
Lenders like AltLINE and Triumph Business Capital, on the other hand, offer invoice factoring.
As you compare your lender options, you’ll want to consider factors including, maximum loan amount, factor rates, qualification requirements, funding speed, lender reputation and customer support.
3. Submit your application
Many invoice financing applications can be completed quickly and easily online. Although the specifics will vary based on your lender, you may need to provide some, if not all, of the following for your application:
- Basic information about your business.
- Business bank statements.
- Business and personal tax returns.
- Business financial statements, such as an accounts receivable aging report.
- Invoices you’d like to finance.
- Personal and business credit scores.
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Frequently asked questions
Is invoice financing a good idea?
Invoice financing can be a good idea for businesses that need to cover cash flow gaps, but it can also be expensive. You’ll want to consider the nature of your business, your industry and the urgency of your funding needs to determine if invoice financing is right for you.
Is invoice financing easy to get?
Invoice financing is often easier to get than traditional financing, because your loan or line of credit is automatically secured against your invoices. Your invoices serve as collateral, which makes you a less risky borrower to a potential lender.
What are the risks of invoice financing?
The biggest risk of invoice financing is that your customer doesn’t pay their invoice. Most invoice financing agreements are recourse, meaning you’re still responsible for repaying the advance and fees if the customer doesn’t pay. Some lenders offer non-recourse financing, where the lender assumes more of the risk — but it typically costs more and has stricter eligibility requirements.
What happens if my customer doesn’t pay?
In most cases, if your customer doesn’t pay their invoice, you’re still responsible for repaying the advance, plus fees. If you refuse or can’t repay, the financing company may take legal action or use collection agencies to recover the debt.
Can I finance government invoices?
Yes, you may be able to finance government invoices. In fact, some companies, like Eagle Business Credit and 1st Commercial Credit, offer specialized programs for financing government receivables.
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