Invoice financing: how borrowing against invoices works

On this page

• How invoice financing works
• What it costs: a worked example
• What happens when sales slow
• Invoice financing or factoring
• When invoice financing fits
• When invoice financing is a bad idea
• SBA's version: the Working Capital CAPLine

How invoice financing works

In invoice financing, a lender advances money against your unpaid invoices and takes a lien on them. You still own the invoices and bill your customers. The OCC's handbook on receivables lending says the loan agreement sets how much control the lender has over customer payments (p. 7).

A borrowing base limits what you can draw. It is your eligible invoices multiplied by an advance rate. The OCC says banks usually advance between 70% and 80% of eligible receivables, with lower rates where risk is higher (p. 17). Your availability is the lesser of the borrowing base or the note amount, minus what you owe (p. 8).

Invoices drop out of the base when they are old, concentrated or exposed to offsets. The OCC treats accounts as ineligible once they pass three times their payment terms, such as 90 days on 30-day terms (p. 19). Government, foreign, affiliate and contra accounts are usually ineligible too (p. 20). A customer holding 10% or more of your receivables counts as concentrated. The OCC says to limit such accounts to 10 to 20% of the base (p. 19).

What it costs: a worked example

Suppose your invoices total $150,000. Assume the lender excludes $18,000 that are more than 90 days old and $22,000 above its limit on one large customer. It advances 80% of what is left. This is an illustration, not a quote.

• Eligible invoices: $150,000 − $18,000 − $22,000 = $110,000.
• Borrowing base: $110,000 × 80% = $88,000.
• Your note is $100,000, so the lesser figure is $88,000.
• You owe $30,000 now. Availability: $88,000 − $30,000 = $58,000.

Now price it. Assume a fee of 1% a month on the balance plus a $250 monthly administration fee. You average $50,000 outstanding for three months.

• Balance fee: $50,000 × 1% × 3 = $1,500.
• Administration: $250 × 3 = $750.
• Total: $1,500 + $750 = $2,250.
• Cost of the money you used: $2,250 ÷ ($50,000 × 3/12) = $2,250 ÷ $12,500 = 18%.

The 1% a month looks like 12% a year. The fixed fee adds six points. Add up every charge in the term sheet, including audit, lockbox and unused-line fees.

What happens when sales slow

The base moves with your invoices, so it can shrink while your balance stays put. Suppose you later draw up to $60,000. Availability is then $88,000 − $60,000 = $28,000.

Now sales dip. Invoices fall to $100,000, and $15,000 of them are more than 90 days old.

• Borrowing base: ($100,000 − $15,000) × 80% = $68,000.
• Availability: $68,000 − $60,000 = $8,000.

If invoices fall to $60,000 and $10,000 are old, the base is ($60,000 − $10,000) × 80% = $40,000. You owe $60,000, so you are $20,000 over the base. On a Working CapitalWorking CapitalMoney for day-to-day costs such as payroll, rent and inventory. Full definition CAPLine, SBA requires the lender to demand a payment that brings the balance within the base. The alternative is more eligible collateralcollateralProperty a lender can take and sell if a loan is not repaid. (Sec. B, Ch. 4, Para. F). Other lenders write their own over-advance terms. Ask what yours says.

Invoice financing or factoring

• Ownership. Financing: you own the invoices and the lender holds a lien. Factoring: the factor buys them.
• Collections. Financing: you usually bill and collect, though the lender may control the account customers pay into. Factoring: customers are told to pay the factor (OCC, p. 33).
• Credit loss. Financing: you bear it, and ineligible invoices shrink your availability. Factoring: the recourse clause decides.
• Fit. Financing suits a continuing need with a steady stream of invoices. Factoring suits a business that wants someone else to take over collection and credit risk.

When invoice financing fits

• A steady stream of invoices to business customers who pay on documented terms.
• Receivables that grow with sales, so your borrowing base grows with them.
• A need that repeats each cycle, where a line sized to your invoices beats one-off borrowing.
• Clean records. The lender will test your invoices, so keep aging reports and proof of delivery current.

When invoice financing is a bad idea

• A few large invoices. One customer above the concentration limit can strip a large share out of the base.
• Disputes, returns and credits. The OCC calls these dilution and says it is usually 5% or less of receivables (p. 19). Higher dilution shrinks what you can draw.
• Falling sales. The base shrinks when sales slow, which is when you need cash most.
• Heavy reporting. Expect borrowing base reports and field audits. Above $2,000,000, SBA requires a borrowing base certificate at least monthly. For smaller lines the SOP says quarterly in one place and monthly in others (Sec. B, Ch. 4, Para. F). Ask which schedule your lender follows.
• Lender control of cash. Check whether customer payments go to an account the lender controls, and how quickly you get the money back.
• A one-time gap. A single large invoice may cost less to bridge with a regular line or a short term loan.

SBA's version: the Working Capital CAPLine

The Working Capital CAPLine is SBA's receivables-and-inventory line.

• Size and term. Up to $5,000,000 and 10 years (SOP 50 10 8.1, Sec. B, Ch. 4, Para. B.1; App. 17, Para. B.5).
• Who qualifies. The applicant must generate accounts receivable, not notes receivable, and/or have inventory (Sec. B, Ch. 4, Para. A.1).
• Advance rates. Maximums are generally 80% of eligible domestic receivables and 50% of eligible inventory (Para. F).
• Monitoring. A line of $1,000,000 or more needs an annual field examination of the assets in the base (Para. F; Information Notice 5000-882227, p. 3).
• Cost. SBA caps the variable rate at Prime plus 3.0 to 6.5 percentage points, depending on loan size (13 CFR 120.214(d)). At the annual review, a lender may charge extra servicing fees on a borrowing-base line. They must be reasonable and no higher than on its similar non-SBA loans (Para. D).
• Another option. The 7(a) Working Capital Pilot offers lines up to $5,000,000 and runs August 1, 2024 through July 31, 2027 (89 FR 57353).