Falling short of working capital is an exporter's worst nightmare. However, if traditional financing solutions don't offer respite, invoice financing can be a good idea for those exporters.
Invoice based financing is the process through which businesses arrange for funds against the amounts to be received from customers. The accounts receivable of the company is sold or attached as security to a third party, which deducts a percentage of the invoice value in exchange for the instant payment.
In a broader sense, invoice financing includes methods such as invoice factoring, invoice discounting, and receivable-based lines of credit. Exporters involved in slow payment cycles can use export invoice financing to speed up the processing of their export orders and to manage their working capital position more efficiently.
Business loans and overdrafts are popular options to strengthen the working capital position of a business. However, invoice financing has its own merits compared to other options:
We must also understand how invoice financing assumes significance in working capital management in the first place. In many businesses, including the export sector, customers do not make their payments at the time of purchase of goods. Instead, they buy on credit. The payment is made later at an agreed date, and the customer is presented with an invoice by the seller that indicates the payment amount and the agreed payment date. By agreeing on a future payment date, the seller sees their funds tied up, which could otherwise have been invested elsewhere.
However, by financing their invoices, sellers can manage short-term liquidity needs or simply cash in on slow-moving account receivables. Until the recovery of the payment, invoice financing remains a form of short-term borrowing, wherein the lending firm or bank releases payment based on the unpaid invoices. In the case of factoring, the exporter sells off the account receivable to the factor (the third party) and gets an immediate cash injection to rejuvenate the working capital situation.
Invoice financing is basically focused on two major conditions i.e. the period of factoring and the discount rate. The discount rate is also known as factor rate. An exporter can opt a better factoring fee if he concentrates on high value invoices. However, the industry rates may vary between 0.5 to 5 percent of the total worth of the factored invoice.
As we saw above, invoice discounting and factoring are popular methods of invoice financing. In the bill discounting facility, the seller receives a significant portion of the invoice value from the lending firm/bank. The lender will receive the invoice as security against the immediate cash release. When the customer pays you, you can repay the lender along with their discounting charges. Alternately, the lender may directly receive the amount from the customer and release the balance invoice amount to you after deducting their discounting and other charges.
The other common method is invoice factoring. In the case of invoice discounting, the customer may not be aware of a discounting arrangement between the seller and the bank/discounting firm. However, with factoring, the seller sells their outstanding invoices to the bank/firm, which in this case is also known as a factor. The factor will pay a significant portion of the invoice value to the seller, like discounting firms. The customer will be aware of this arrangement and will have to pay the invoice value to the factor, and not to the seller. The factor will release the remaining invoice amount after deducting factoring, collection, and other applicable charges.
This recivables credit line offered by banks and financial institutions as a percentage of the value of outstanding invoices. The value is calculated based on the age of the invoices. Accordingly, invoices whose payment dates are nearer will be subject to lower charges. The credit availed of by the seller gets reduced as and when an invoice is paid by the customer.
If you are availing of invoice financing facilities from your bank, most of your KYC and other details will be already available with them. However, in case of a first-time arrangement with a new financial institution, you should keep the following documents handy, in addition to any specific requirement they may seek:
The documentation is made simple in the case of invoice factoring by fintech companies like Drip Capital. One can submit the invoice digitally on our portal to kick-start__ an easy and fast bill discounting process. The need for further documentation will depend on Drip Capital’s internal assessment of the business.