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Low-interest rates and higher returns have become new norms of the lending industry. That’s why borrowers around the world have turned towards alternative sources of finance in search of faster credit solutions. Consequently, banks have become less preferable for borrowers looking for quick and easy loans. 

In major markets, alternative finance models like peer to peer (p2p) lending, crowdfunding have gained immense popularity amongst businesses. They tend to offer various benefits above the lending services that attract a huge number of borrowers every year.

Invoice financing or invoice trading is one such way for businesses to borrow money against the amounts due from customers or debtors. Invoice financing is proving to be a better credit solution for small businesses in developing countries like India and Australia. In fact, a 2016 report by KPMG said that invoice financing is the fastest growing alternative finance model in the Asia-Pacific region, excluding China.

Let’s get in-depth and understand the basics of invoice financing, how does it operate, and how it could impact small and medium enterprises.

Understanding invoice financing

Invoice financing allows businesses to sell individual invoices via online platforms (generally) to gain quick funds that would otherwise be tied up. By offering a unique opportunity to sell invoices, it helps businesses to improve cash flow and fill the gap in working capital cycles. The concept adopts the principles of p2p lending and applies to the invoice finance. The concept is sometimes also referred to as ‘auction-based invoice finance.’

Any business (majorly SMEs) looking for quick funds can sell their invoices on an online platform and get 80-90% of the face value of the invoice instantly. Invoice trading platforms act as a mediator to connect businesses (sellers) and investors (buyers). 

How does it work?

Let’s now know how a typical invoice financing transaction works –

  1. A company applies online to become a verified member of an invoice financing platform.
  2. The company then uploads the invoice(s) to be verified and offered to buyers.
  3. Once verified, buyers bid to buy small slices of the invoice, which is managed by the platform.
  4. As the company accepts the bid, the platform disburses the fund (80-90% of the face value) against the invoice to the company’s registered bank account.
  5. The remaining 10-20% less the platform’s fees is transferred to the company’s account once the end debtor pays the invoice in full.
  6. Buyers receive money at the end of the tenure.

The online lending platform manages every step right from the registration of the user to transfer the fund. They tend to simplify complexities for users looking for instant cash. Apart from core services, several functionalities like accounting, KYC, decision-making, and payment integration are offered by these platforms.

Companies looking to leverage the flourishing online lending market by building their own platform must know the right structures and put the right technology and business model in place. Akeo Lending helps businesses with a customizable lending framework that allows building the lending platform in a drag and drop fashion. The 360-degree lending solution comes with modular back-and-front-end architecture and a host of pre-built features including – rule-based calculations, adaptable UI, automated KYC/AML, and third-party integration.

Types of invoice financing

Invoice factoring

Invoice factoring is a type of invoice financing that converts invoices due to immediate cash. With factoring, the factoring company takes control over the sales ledger, credit, and chasing customers for settlement of the invoices. The debtor or the customer settles the invoices directly with the factoring company.

Invoice discounting

Invoice discounting is a type of invoice financing where a company uses its unpaid account invoices as collateral for a loan, which is issued by a bank or financing company. With invoice discounting, the company retains control over the sales ledger and chases payment in the usual way. The debtor or the customer settles the invoices with the company only unlike invoice factoring.

Selective invoice financing

Selective invoice financing offers companies with more control over which invoices they wish to sell. Instead of submitting the entire sales ledger, the company can decide and choose which invoices it wants to sell.

Impact on the SMEs

Borrowing money against future revenue could be a significant way to get finance for small and medium enterprises (SMEs). Invoice trading, in all its characters, can play a major role in streamlining the working capital cycle for businesses. While this mode of business finance is still new to major markets and has its cons, it has already enabled SMEs to raise short-term finance with numerous other benefits:

  1. Easy and quick capital,
  2. Benefits in terms of cash inflow and outflow,
  3. Faster processing time and
  4. Asset security

Today, there are a number of invoice trading platforms which offer a flexible way of obtaining funds without any of the contractual tie-ins. It will be interesting to see how invoice financing will mature in the future to help not only SMEs but also big corporates.