Timely access to funds is one of the greatest challenges for any business – small or large. Invoice financing is one smart way of borrowing funds for business continuity. It’s a system of lending that allow companies to unlock cash tied up in unpaid invoices. Many banks and NBFCs in India offer invoice finance especially to small and medium businesses as a quick and effective solution to working capital challenges.

In this blog, we will take a closer look at invoice financing to understand how MSMEs can use it to plan finances and keep growing their business without any strain. We’ll take a look at how invoice finance works, examples, and how it provides a cushion during sluggish customer payment cycles.

What is invoice financing?

Let us start with the meaning of invoice finance – What does invoice financing mean?

Invoice financing is a financial credit facility that allows you (as a business owner) to borrow funds (i.e., advance) against your unpaid, approved customer invoices. Here the unpaid invoice acts as a collateral where there is a promise of awaited payments in future. Based on the due amount, your eligibility and lender’s rate of interest, a small charge or fee is collected against the sum lent out.

It is also known as accounts receivable financing, since the loan is provided against amounts yet to be received from customers.

The funds (advances) borrowed can solve immediate liquidity problems and allow businesses to conduct daily-operations hassle-free. It also gives businesses the safety net and momentum required to keep cash flowing when payments are delayed. (Also read: New 45 day rule for MSME payments)

This approach to managing receivables is transforming how businesses operate. However, since this is a unique solution, not every lender provides it. Lenders like HDFC Bank, SBI and Bajaj Finserv provide this service as a lifeline to cash crunch challenges. As a business owner, looking to avail invoice financing for business, ensure that you are eligible and can leverage your outstanding invoices.

How invoice financing works and is calculated (example)

Now that we have defined invoice financing, let’s take a practical example of invoice financing services.

Company A sells goods to Company B worth ₹2,00,000 with a payment duration of 90 days. That is, Company B will have to pay Company A within the next 90 days.

Now, during this period, to ensure that daily operations are not impacted and the business does not face any cash crunch, Company A can opt for invoice financing.

It can approach a bank/NBFC with its approved, unpaid invoice of ₹2,00,000 and apply for funds/loans against it. Based on the credentials of the borrower, the due amount, and other terms, the lender will agree to offer a certain percentage of the invoice value as loan to Company A.

Invoice financing calculation for lending

For example, if the Bank approves 85% for lending then:

=85% of ₹2,00,000 = ₹1,70,000

That is, against the due invoice amount, Company A can get an advance of ₹1,70,000 from the Bank.

In most cases, lenders offer 80%-95% of the total value of the invoice as advance.

The Bank will also charge a fee (i.e., factor fee), usually 0.5% to 3% per month, for the 3 months (90 days). If, the fee is 2%, then:

=2% x 3 x ₹1,70,000 = ₹10,200

Unlike a business loan where the interest amount diminishes as you pay up your loan, in invoice discounting, the amount remains the same throughout. In most cases, a repayment tenure of 30, 60, or 90 days is opted for, though it is flexible and as per the rules of the lender.

Invoice finance calculation of actual amount lent

At the end of 90 days when the business is paid, it will get the remaining 15% of the invoice amount, less the interest/fee charged.

=₹15% of ₹2,00,000 = ₹30,000 – ₹10,200 = ₹19,800

Total amount received = ₹1,70,000 + ₹19,800 = ₹1,89,800

This example illustrates the utility and calculation method of invoice financing in India, showcasing its importance for business liquidity.

Also read: Pradhan Mantri business loans schemes for MSMEs – for businesses looking at lending alternatives

Alternatives to invoice financing

While invoice financing is a very smart way to keep your fund in check and business rolling, there are other options that you can consider – namely, invoice factoring and bill discounting.

Though conceptually these financial tools operate similarly, i.e., getting an advance/loan against pending invoices, there are some minor differences between them which are likely to impact your choice of one from the other.

Difference between invoice financing and invoice factoring:

What is invoice factoring?

Invoice factoring involves selling invoices to a factoring firm (third-party). The firm will collect payments directly from the customer, which means that the customer will have to be aware of the arrangement made. In most cases, this system is opted for large invoices involving multiple batches.

Here’s a brief comparison of invoice financing vs invoice factoring.

Invoice financing vs Invoice factoring

In a nutshell, when it comes to invoice financing, you are basically taking credit against your accounts receivables. With invoice factoring, you are selling your invoices to the factoring firm.

Also read: Types of business finance – Funding options for MSMEs in India

Difference between invoice financing and bill discounting

We’ve understood what is invoice financing and how it’s different from invoice factoring.

Now let’s look at – what is bill discounting?

Bill discounting is the practice where a company can sell its due invoices to a lender/financer at a discount. For example, in our previous example, Company A could have sold its due invoices of ₹2,00,000 to a lender, before its 90 days timeline, at a discount. If the discount was 5% then the lender would have discounted ₹10,000 (i.e., 5% of ₹2,00,000) and Company A would have got ₹1,90,000.

Invoice financing vs bill discounting

When it comes to bill discounting, the actual onus of collecting the debt is on the lender/financer. It is recommended to MSMEs that if they are choosing to opt for this financing option, they speak with their customers first, familiarising them with the new/change in financial arrangements. This will ensure that even though the MSME is not involved in collection of payments, they can still maintain good customer relationship for future contracts.

Also read: Business ideas under ₹10 lakhs – for those wanting to start their own business

Advantages and disadvantages of invoice financing

Invoice financing in India can be beneficial for small businesses. It’s a strategic tool to avail funds and remove cash crunch challenges, especially when payments are delayed from customers.

Though the government has set up programmes to address MSMEs grievances on delayed payments (i.e., the MSME Samadhaan portal) it’s always advisable to know about your funding options.

Invoice finance, like all other financial services, comes with its own merits and demerits. Let’s understand them to help you make informed financial decisions.

Advantages of invoice finance

• Immediate access to cash: Funds can be accessed within 1-3 business days after approval.
• Business growth opportunities: Since one does not have to wait for the actual period of accounts receivables from the customer, businesses can operate as usual and use the funds for growth, purchase of raw materials, payment of salaries, etc.
• Flexible borrowing options: Lenders usually provide flexible borrowing and repayment terms. Since an interest rate and fee is charged, borrowers can negotiate the terms of repayment.
• No collateral required: This is a form of collateral-free borrowing, where the invoice is the collateral and no other collateral needs to be pledged for availing funds.
• Suitable for any value of invoices: Invoice financing can be availed on invoices of any value. Though lenders might have their own cut off parameters, you can seek funds against an invoice of ₹50,000 or ₹50,00,000.

Disadvantages of invoice financing:

• Higher fixed interest rates: The interest rate is fixed and higher than traditional business loans from banks, NBFCs, or government loans.
• Industry suitability: Invoice discounting is not recommended for all businesses. For instance, if you have won a government contract, there is little risk of non-payment or delayed payments. Hence, this is a suitable invoice for financing. However, for businesses like construction and building works, slight delay in payment period is the norm. Hence, this form of financing might not be suitable.
• Creditworthiness of the borrower: The option to provide funds against an invoice lies with the lender. Hence, it depends on the creditworthiness of the borrower, relationship with the lender, business financial records, etc. Since lenders will want to minimise their risks, they will prefer to lend funds to reliable borrowers, who are pledging invoices for reputed and reliable businesses.

Checking your eligibility for invoice financing and if it’s right for you

The eligibility criteria for invoice financing differs between lenders. Most lenders however look for the following:

• Business finances, business credit report, and individual creditworthiness of the borrower
• Reputation and reliability (previous payment history) of the end client, that is, the customer liable to pay the invoice
• Other loans and debt of the company, that is, how much debt the company owes and what’s the history of loan repayment
• The terms of the outstanding invoice
• Industry relevance and feasibility

Invoice financing therefore can be a suitable credit facility if you meet the required criteria. If not, consider other financing options that provide betters terms for you.

Author: Sohini Banerjee

Sohini is a seasoned content writer with 12 years’ experience in developing marketing and business content across multiple formats. At Tata nexarc, she leverages her skills in crafting curated content on the Indian MSME sector, steel procurement, and logistics. In her personal time, she enjoys reading fiction and being up-to-date on trends in digital marketing and the Indian business ecosystem.