FAQs on invoice financing

FAQs on invoice financing

FAQs on invoice financing

Invoice financing is a short-term financing source that is prominent among businesses globally. It is a useful mechanism for businesses to convert outstanding invoices into liquid cash. One can fund their working capital requirements by financing outstanding invoices.

How does invoice financing work?

Invoice financing involves selling outstanding invoices to a third party at a discount. Invoices can also be discounted with the buyer, wherein the debtor advances the invoice value at a discount. At the time of maturity of the invoice, the seller or seller’s bank collects the invoice value from the buyer and repays the financing entity.

Who provides invoice financing services?

Generally, invoices are discounted with third parties, including banks, NBFCs and other financial institutions. Invoices are also discounted by the buyer who agrees to pay the invoice amount earlier at a mutually agreed discount.

Is invoice financing a type of borrowing?

Invoice financing is a short-term borrowing when advances are given against invoices. However, when invoices are discounted through an invoice financing platform, it can’t be classified as borrowing as the payment is made to the creditor (vendor) by the debtor (buyer). Therefore, borrowings via invoice financing do not appear in the balance sheet and are disclosed as accompanying notes in the financials.

How are discount and interest rates set?

The financial institutions set the discount and interest rates as per their lending terms. The rates are based on the tenure of the advance. The rates may range between 5%-8% p.a. When invoices are discounted via an invoice financing platform, the buyer and the vendor mutually agree upon the rates.

What is the repayment period for invoice financing?

The tenure is the credit period that the seller agreed with the buyer as per the terms of sale. The period gets over on the last date of the credit period of the invoice or on the date of payment of invoice value, whichever is earlier.

What are the types of invoice financing?

Invoice financing primarily consists of two types: Recourse and non-recourse. 

Recourse invoice financing is where the financing entity is provided security against any defaults in the financing process. Hence, the seller is responsible in case of any default.

Non-recourse invoice financing is where the financing entity assumes full liability in case of default by the buyer. Hence, the buyer is fully responsible for any defaults. 

What are the advantages of invoice financing?

Invoice financing helps fuel working capital requirements. It helps convert funds trapped in the form of receivables into usable liquid funds. Hence, businesses need not wait until the credit period ends to realise the amounts.

What are the disadvantages of invoice financing?

Invoice financing places additional finance costs for the business and impacts profits. Over-reliance on invoice financing can expose the business to higher costs and legal consequences. Invoice financing is available only in the case of business-to-business invoices, which limits its scope for businesses that primarily sell to the general public.

Is credit rating important for obtaining finances through invoice financing?

Like traditional finances, credit rating is checked during invoice financing. In the case of non-recourse financing, the finance depends on the buyer’s credit rating.

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