Invoice financing has fast become one of the most popular and in demand ways of raising the needed resources or capital among entrepreneurs today. It’s charm lies in the truth that it does not create the same consequences as that of bank loans and other forms of credit. As a matter of fact, it does not appear as a liability in one’s financial statements either. So exactly how does invoice financing work? Read on to find out.
Per definition, single invoice financing is a form of short term borrowing that allows an entity to draw cash against its sales invoices before the customer has sent in partial or full payment. Let’s take it step by step.
- First, the entity chooses which invoices it will subject to the financing and when. The company will have to decide whether it prefers complete or single invoice finance. In the case of the former, all customer receivables will be subjected to the service for every period, often on a monthly basis, for a specific period of time. The latter on the other hand is individual in nature so the company gets to handpick which invoice it would like to use as well as how often they would like to do so. The choice is often directed to those receivables that have significant values or those that pose threats of un-collection.
- Second, it sells the right to collect against the chosen invoices to the provider. The reason why this financing method does not fall under the category of a debt is because it is in fact a sale of an asset. The right to collect is passed on from the company to the financial provider. The latter provides an amount that is at least eighty percent equivalent to the value of the invoice/s with the balance to be forwarded after full collection from customers is achieved.
- Third, collection is performed by the provider and the company uses the funds as deemed necessary. The financial provider now bears the responsibility of collection. In some agreements should a customer default in payment, the loss is borne by the financing company. This allows for reduction in losses from bad debts.
- Fourth, once collection is completed the balance is then forwarded. After collection from customers, the invoice financing company will now forward the remaining balance less fees to the company.
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