What is Invoice Finance?

Still waiting on those clients to pay their bills? We’ve been there. For businesses of all shapes and sizes all across the world, late or missed customer payments can have a ripple effect that’s hard to combat—you could miss employee wages, supply payments, and face serious cash flow problems.

But don’t panic! If you know how, there are tried-and-tested ways to fight cash flow issues caused by unpaid invoices.

You might be thinking we’re talking about bank loans. If so, you’re only half right. Bank loans for businesses often come with strict terms and high interest rates, which can actually exacerbate your cash flow problem if you’re not careful.

What’s more, traditional loans can take a while to come through. In the Philippines, businesses could wait up to 75 days to get approved. If you’re in need of cash here and now, that’s not much good to you.

But there’s an alternative—invoice finance.

In short, invoice finance lets you access funds quickly by using unpaid invoices as collateral.

How does invoice financing work?

So, your customer has missed a payment, or perhaps they have up to 90 days to pay and you need the cash flow ASAP. Either way, invoice financing is a popular way for businesses in the Philippines to access cash without having to take out a traditional business loan.

Here’s how the whole thing works:

1. Choose an invoice financing provider: You’ve got your unpaid invoice, and you want to get it paid to enhance your cash flow and keep business moving. The first step is to choose an invoice financing provider—also called a lender or a factor.Don’t necessarily go for the first lender that crops up, though—spend time reading reviews and finding a reputable company from which to borrow.
2. Submit your invoice: Once you’ve chosen your factor, you’ll have to submit your unpaid invoice for approval.
3. Receive an advance: Next, the finance company will pay you (the business) a percentage of the invoice value (typically 70-95%). They’ll pay the rest when the customer pays the invoice in full.
4. Customer pays the invoice: Now, it’s a case of waiting for the customer to pay the bill. There are usually two ways to go about this: either the customer pays the business, who then repays the lender, or the lender takes the payment directly from the customer. 
5. Receive the balance: Once the invoice is paid in full, the lender releases the remaining balance—minus their fees, of course (which are usually around 1-5%). 

While invoice financing may seem complicated, it’s actually a pretty straightforward loan type. The only complications that could arise would be to do with fee rates and customer refusal.

Types of invoice finance

There are two main types of invoice financing—invoice factoring and invoice discounting. Knowing which is which, and which type is right for your needs, is crucial before you go looking up lenders near you.

Let’s explore the key differences so you don’t get caught out by a bad deal.

Invoice factoring

Invoice factoring is where a lender buys the invoice from the business and takes responsibility for it. Here’s what that means in practice:

• Who collects payment? The factoring company (or lender).
• Advance percentage: Typically 70-95% of invoice value.
• Control over sales ledger: The factor manages the invoice payment.
• Does the customer know? Yes, because they pay the factor.
• Costs: Sometimes slightly higher, as the factoring company will need to collect the payment.

So why would a business choose invoice factoring? Let’s see:

• Save time and resources: Don’t worry about chasing payments, simply outsource the problem.
• Potential bad debt protection: Some factoring companies offer non-recourse factoring.
• Faster cash flow: Gain access to essential funds much quicker and forget waiting for customer payments.

Invoice discounting

Invoice discounting is a little different. It can save you some money, but it also takes more work and could take a little longer. That said, it’s still one of the most popular ways to increase cash flow quickly and easily for businesses in the Philippines. Here’s the lowdown:

• Who collects payment? The business itself (not the factor).
• Advance percentage: Typically 80-95% of invoice value.
• Control over sales ledger: The business retains full control over the ledger.
• Does the customer know? No, since the business collects the payment as normal.
• Costs: Usually a little lower because you (the business) handle collection yourself.

Sounds like more work, right? Well, for many businesses, invoice discounting is still preferred. Here are a few major benefits to consider:

• Confidentiality: As your customers don’t know about the invoice financing, this can help keep your reputation spotless.
• Control over customer relationships: You manage collections and customer communications.
• Lower costs: Discounting is generally the cheaper option.

Which type of invoice financing is best for me?

This depends on your business needs. In the Philippines, both financing types are popular, and while the differences between them may sound negligible, they have distinct differences.

Invoice factoring is best for you if:

• You’d rather outsource payments and relieve yourself of the problem
• You have a small finance team and could do with some help
• You have customers with long payment terms

Invoice discounting could be better for you if:

• You value confidentiality
• You have a strong credit control process
• You have an established business with a good credit history

Benefits of invoice financing for businesses

Did you know that nearly half of all MSME businesses in the Philippines experience cash flow problems? With those kinds of numbers, it’s no wonder invoice financing is such a sought-after solution. 

But that doesn’t necessarily explain why businesses choose invoice financing over, say, other types of loans. Why is this type of loan, in particular, so popular? 

1. Improved cash flow

Invoice financing, whether it’s invoice factoring or invoice discounting, can solve a number of cash flow issues in the blink of an eye.

Of course, it won’t prevent you from having to rely on invoice financing in the future, but it will secure you the cash you need in a relatively short space of time.

If you’re having trouble paying employees or paying for supplies, for instance, then invoice financing represents a quick fix with minimal risk.

2. Reduced dependency on traditional loans

For many, invoice factoring and discounting are far preferable compared to traditional bank loans. In part, that’s down to the complex and time-consuming processes involved in taking out a traditional loan.

Traditional lenders may ask for more documentation, and will almost certainly take more time to get back to you with their answer. Don’t like the sound of waiting 45-75 days for approval? That’s where invoice financing comes in.

And don’t forget, traditional loans may have stricter terms and higher interest rates, too, which can make them economically off-putting (as they could lead to further cash flow problems later down the line).

3. Quicker access to funds

Remember when we mentioned traditional loans can take up to 75 days to get approved (or, for that matter, declined)? Well, many invoice factors offer immediate loans, often within just 24 hours.

For many businesses, that’s a super tempting alternative. Many common cash flow problems require immediate response, and invoice financing can come to the rescue.

How can invoice factoring improve cash flow?

You know invoice factoring provides businesses with quick cash by converting unpaid invoices into actual capital. Instead of waiting 30, 60, or 90 days for customer payments, why not get most of the money right now? 

But how exactly does this work? And how might a business like yours use invoice factoring to boost that much-needed cash flow?

Let’s explore some examples that might help flesh out the picture:

1. A manufacturing company that wants to scale up

Let’s imagine there’s a small manufacturing firm that lands a large order from a big retailer. It’s great news, but they need to buy raw materials for the job and they don’t have the funds. 

Instead of taking out a loan, the firm factors its outstanding invoices and gets immediate cash. Order fulfilled!

2. A staffing agency with payroll troubles

Some staffing agencies that place employees at client companies only receive payment after 60 days. This can be a problem.

To jump this hurdle, a staffing agency in this position might use invoice factoring to bridge the gap, ensuring seamless payroll management and employee retention.

3. A logistics firm expanding its fleet

There’s a trucking company that’s on the up. They’re experiencing a surge in deliveries, which is great news for business, but they haven’t got the fleet to keep up.

The solution? Factoring invoices. This way, they get the cash needed for vehicle maintenance and fuel costs, keeping operations running smoothly.

Hopefully, these examples show you the ways in which invoice finance can be used to overcome different cash flow problems quickly and easily.

How invoice financing compares to other financing options

So, why exactly is invoice financing seen as a preferable route to improved cash flow? Surely there are other, more traditional ways to achieve this?

Well, there are, but they don’t all offer the same benefits as invoice financing. That’s not to say there’s never a time or a place for other financing options. It's just that invoice financing offers several key advantages.

Let’s explore how invoice financing compares to traditional loans and lines of credit. We’re going to break this down into five key areas:

Approval process

With invoice financing, approval is fast. Lenders can provide quick loans because they’re based on invoices and customer creditworthiness.

• Traditional loans: Approval is often much slower. It requires business financials, collateral, and credit history—to name just a few things!
• Lines of credit: Here, approval could be quicker than a traditional loan, but it depends on business credit and revenue. Invoice financing is still almost always quicker.

Collateral required

In an invoice financing model, the invoice itself serves as collateral, meaning no physical assets are required.

• Traditional loans: A loan usually needs to be backed by physical assets like equipment or property. 
• Lines of credit: A line of credit may require collateral or strong business credit.

Repayment terms

Here, it depends on what type of invoice finance you’re using. Generally, though, repayment (including fees) is usually automatic when the customer pays their bill.

• Traditional loans: Expect to pay back a standard loan over fixed monthly payments instead.
• Lines of credit: Lines of credit also use fixed payments, however, unlike invoice financing, interest can accrue rapidly.

Speed of funding

Again, invoice financing is speedy. You can usually expect to receive a payment within 24-48 hours, which is amazing if you’re in a pinch. Other loan types are much slower:

• Traditional loans: Can take weeks or even months in some cases.
• Lines of credit: Faster than loans but slower than invoice financing.

Impact on balance sheet

Invoice financing is usually off the balance sheet, meaning it doesn’t add to your business debt. Great news! On the other hand:

• Traditional loans: Add to business debt.
• Lines of credit: Add to business debt.

Common misconceptions about invoice finance

If you’re reading about invoice financing for the first time, you may be hesitant to take the plunge. That’s understandable. But we’re here to assure you that, provided the factor in question is legitimate, this method of cash flow financing is trustworthy. 

Let’s take a few common myths and see just how well they stack up against reality:

1. “It’s the same as a loan”

Wrong. Invoice financing is an advance. You’ve already earned the money. Plus, it doesn’t add debt to the balance sheet (unlike a loan), which makes it much more flexible.

2. “It’s too expensive”

Sure, invoice financing comes with fees (usually 1-5% of the invoice value). But it’s often much more affordable than a traditional loan or a line of credit. Those types tend to include high interest rates, too.

3. “It’s complicated”

It depends on the provider, but not really. Invoice financing is specifically designed to be quick and easy. You’ll usually get approval within 24 hours.

4. “Invoice financing is only for struggling businesses”

Invoice financing combats cash flow problems, not profit problems. It’s actually very popular with growing businesses that simply face temporary liquidity gaps.

5. “Customers will lose trust”

Invoice discounting is actually invisible to customers, so they won’t even know. Professional factoring companies work in a way that maintains customer relationships, too.

Conclusion: Is invoice finance right for your business?

Hopefully, we’ve cleared the mist on invoice financing and how it can improve cash flow. While terms like these can be daunting, they’re often much simpler than they sound.

Both types of invoice financing, though different, offer businesses the chance to plug cash flow gaps from late or missed customer payments quickly and cheaply, without taking out an interest-heavy loan.

All you need to do to get started on your invoice financing journey is to find a reputable factor who can cover your needs. From there, it’s usually a super quick, hassle-free process. 

Ideally, businesses will be able to guarantee punctual customer payments and avoid the need for invoice financing altogether. To help achieve this, why not try QuickBooks’ professional invoicing software—try it for free with our 30-day free trial!