How Alternative Data Sources Can Support Invoice-Based Financing for SMBs
Business loans are essential for various activities like investing in a new opportunity, expansion, covering operating expenses, and refinancing. Contrary to popular belief, most business loans are not taken out to save a sinking ship, but to cover expenses including payroll, rent, marketing, administrative, sales, and distribution. Nevertheless, the approval rate for small business loans in the U.S. is only 62 percent.
Though most small and medium-sized businesses are paid in cycles, the business operations keep running throughout the year. Additionally, increased competition in the market forces these businesses to look for easily dispensable sources of financing. Most of these needs get fulfilled by short-term business loans, investors, and invoice-based financing to name a few.
Increased competition in the market forces businesses to look for easily dispensable sources of financing.
Determining the type of financing
There are generally two types of invoice financing: invoice factoring and invoice discounting. The factoring method allows the invoice financier to collect the debt from customers directly; however, in the case of invoice discounting, the company themselves are responsible for collecting the debt.
In invoice discounting, the customer won’t know that the business is using invoice-based financing to collect the debt. These modes of payment attract financing at higher rates than the prime rate. To retrieve funds, suppliers can sell the bills to an invoice discounting company, a bank, or a group of individuals via a P2P platform.
The need for invoice-based financing in the age of fintechs
Many primary businesses act as mere manufacturers and sell goods to wholesale dealers. These business models are mainly prevalent in countries with primarily manufacturing-focused companies like China, the U.S., India, and Bangladesh. Customers of these manufacturers usually offer 30 to 90-day accounts payable terms. This AP lag locks the payment amount for the suppliers until the payment gets cleared, thus raising the need for invoice discounting.
Invoices and their associated value
The invoices from creditworthy commercial clients sold by sellers with good invoicing practices act as a guarantee to the lender. The debt is primarily collateral-free, and the funding amount typically ranges from 80 to 90 percent of the value of the invoice. Such a mode of financing works mostly for companies with high-profit margins because the interest rates associated are fairly high. Past default rates and on-time payments have been the key metrics for measuring the performance of sellers.
Invoice financing is sustainable only for high profit-margin companies, because of high lending rates.
Simplify invoice-based financing with alternative credit scoring
Since no credit rating or collateral is associated with invoice financing, interest rates are typically very high. Alternative data sources have the potential to support better credit scoring and risk decisioning for lending decisions. Most of these manufacturers have high utility consumption, which could provide deeper visibility into payment capabilities for informed lending decisions.
Urjanet provides access to consent-based utility payment history from thousands of utility and telecom providers worldwide for both consumers and businesses. By integrating alternative credit data into your credit modeling process, you can mitigate risk effectively and close the lending gap. Contact a utility data expert today to get started.
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About Ayan Kumar
Ayan is an Assistant Manager at Urjanet, assisting with content development, GTM strategy development, and execution. When he is not working, he enjoys reading about tech, playing cards, board games, and traveling.