Small and medium-sized enterprises (SMEs) and business-to-business (B2B) firms have embraced the necessity of maintaining consistent cash flow or credit lines to clear dues and support their day-to-day operations. SMEs and B2B firms constantly look for funding options that suit their needs, ensuring consistent cash flow. As a result, loan against invoices or loan invoicing has garnered significant popularity in recent times for many reasons, including instant availability, the hassle-free application process, and collateral-free funding. Besides, applying for a loan against invoices is also a great funding option for new businesses that need to generate cash.
Read on to learn more about loans against invoices and whether they are valuable to lenders.
Understanding Loan Against Invoices: An Outline
Before we get into the details of a loan against invoices, let us first understand what it means.
A loan against invoices is a good short-term loan alternative for businesses, enabling them to secure loans against unpaid invoices. In this case, unpaid invoices act as collateral, and businesses can pay off the loan once their customers clear their invoices.
Many B2B companies that typically allow customers to buy goods and services on credit rely on loan invoicing to ensure seamless cash flow. Businesses have to bear the brunt when their customers do not clear their invoices, leading to a shortage of funds.
This is where it comes in handy, providing businesses with immediate access to funds.
Moreover, these funds can then be used to pay salaries, and members of the value chain, expand operations, and clear other payments.
Loan Against Invoices: An Example
A business operating in a rented place must pay ₹15,000 in rent but is short of funds.
If the business has a few outstanding invoices worth ₹40,000 with a few customers that usually pay their dues on time, they can secure a loan against these unpaid invoices to pay rent and repay the loan once their invoices are paid.
Another reason why invoice financing has garnered significant popularity is because it is comparatively easier to secure a loan than a regular business loan.
Loan Against Invoices for Lenders: 5 Key Advantages
After understanding what a loan against an invoice is and how it works, let’s examine its advantages for lenders.
1. Better returns
Loan invoicing provides better returns than conventional lending options, including a line of credit and term loans. Since loan against invoices has a relatively shorter repayment cycle and higher interest rates, it yields better results for lenders.
2. Notably, lower default rates
Past trends suggest that loans against invoices have lower default rates than other lending products. One of the major reasons for this is that a borrower’s invoices are used as collateral for the loan, simplifying it for lenders to recover funds in case someone defaults.
3. Portfolio Diversification
Many financial institutions are increasingly focusing on diversifying their lending portfolio and improving their bottom lines; invoice financing is a great way to achieve that. This also allows creates an alternative source of revenue for all lenders looking to explore this avenue.
4. Quick turnaround
Typically, a loan against invoices provides a faster turnaround than traditional lending options, as the borrower’s receivables are generated and verified. This is another area where invoice financing pips other conventional lending products.
5. Repeat business
Loans against invoices could potentially mean repeat business for lenders as borrowers may occasionally need instant access to funds. Therefore, lenders that provide spotless customer service can forge long-term relationships with their customers and expand their customer base.
Some Potential Drawbacks of Loan Against Invoices for Lenders
While loan invoicing provides a gamut of advantages to lenders, it comes with a few downsides. Here are some of the most common challenges and disadvantages linked with it:
1. Higher risk
This is primarily used by small to medium-sized B2B firms with a higher risk of defaulting on their loans. Therefore, loan financing can become unpredictable and perilous for lenders offering loans against invoices.
2. Minimal collateral
Invoice financing can be broadly categorised as unsecured financing, meaning that lenders have limited collateral to work in the event of default. This can make it difficult to recover funds if their customers default on the loan.
3. Complicated process
Invoice financing can be complicated for lenders with little or bare minimum understanding of a borrower’s business. Here, lenders must get familiar with the borrower’s cash flow and operations before sanctioning a loan against their invoices.
This process could take time and make it difficult for lenders to determine a borrower’s creditworthiness.
4. Overemphasis on B2B firms
While both can benefit from traditional lending products, B2B and B2C firms, a loan against invoices is not an option for B2C companies as they receive money at the point of sale.
As a result, B2C firms do not consider loan invoicing a short-term fix if they face cash flow problems.
Loan Against Invoices – Opportunities and Risks for B2B SMEs and Lending Firms
Loan against invoices is an excellent way for B2B SMEs to secure short-term loans when their cash flow is disrupted due to delayed payments and unpaid invoices.
Even lending firms reap significant benefits as they diversify their lending portfolio, expand their customer base, and solidify their foothold in the market. That said, lenders need to be aware of a few risks linked with loan financing.
Trust Finezza to help you improve and manage your lending portfolio. Our lending management services are crafted to assist lenders in navigating the challenges involved in loans against invoices.
Finezza’s loan management solution is trusted by some of the most established companies in India, including UC Inclusive Credit, Hiranandani Financial Services, and ftcash, to name a few.
Book a demo to discover more about Lending Lifecycle Management Platform.