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Invoice Financing in the Blockchain Age

Business.com / Financial Solutions / Last Modified: March 27, 2018
Image credit: Alexander Yakimov/Shutterstock

Blockchain isn't getting attention just for its association with cryptocurrency, it's also changing the world of data and business in the process. Here's how blockchain will play an impacting role in the world of finance and business transactions.

When your typical Joe or Jane off the street is asked about cryptocurrencies and the blockchain, many of them have a "deer caught in headlights" look. This is largely new territory for a lot of people, and even among those who are a little more knowledgeable, they're likely more familiar with the "gold rush" phenomenon of chasing cryptocurrency gains, or trying to turn a fortune from mining.

But the real power and potential for radically changing the world for the better will not be found in the fluctuating nature of a cryptocurrency’s prevailing value on the open market. Instead, it comes from the underlying blockchain technology, and how it can be applied to an increasingly broad range of business situations. One terrific example of this is invoice financing.

How Does Invoice Financing Work?

Let's say Buyer A decides to buy $1,000 in widgets from Company B. The payment terms for that order are such that Buyer A should pay Company B within 45 days. Meanwhile, Company B is running into some temporary cash flow issues and needs to have some more cash on hand right now. So, Company B "sells" the invoice for that order to Lender C.

There are a few different scenarios that all fall under the umbrella of invoice financing here. One possible example is that Lender C inspects and verifies the invoice associated with that order, and decides to lend $800 to Company B, based on the assumption that Company B has a legitimate accounts receivable of $1,000 from Buyer A. When Buyer A finally pays that invoice a few weeks later, Company B can then repay Lender C on the $800 loan, plus interest and fees.

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A New Solution to Old Problems

This kind of traditional arrangement, or some variation of it, is very common in the business world. It's used every day by everyone from small mom and pop shops all the way up to Fortune 500 companies. The basic mechanisms are fundamentally the same, even if we're talking about the difference between $1,000 and millions of dollars at a time. And while such an arrangement is common, it is also riddled with all sorts of complications and difficulties.

There's no real way for Lender C, for example, to really know much of anything about Buyer A. Company B might say that it issued an invoice for $1,000, but what if Buyer A is a difficult customer who is currently demanding a refund? What if Buyer A never pays that invoice? Lender C has a direct relationship with Company B, but the relationship with Buyer A is a little more indirect and thus shrouded a little more in uncertainty.

This is one of the ways that the blockchain can help to provide a better, more transparent invoice financing experience for all parties involved. There are now companies offering decentralized invoice financing. 

As with other applications of the blockchain, these companies use a distributed ledger. In doing so, it is possible for any party involved in the transaction – buyer, seller or investor – to verify the identity and legitimacy of any other party instantly. Under traditional invoice financing, such a process is imperfect and slow. But when the buyer is involved in the invoice financing process, they can also be involved in adjusting the payment terms.

Remember that using the blockchain as part of the invoice financing process also means that businesses can move beyond the confines and restrictions of traditional static invoices toward dynamic invoices that are on a distributed ledger. This again lends itself to greater transparency and trustworthiness, because the legitimacy and details of the invoice can be instantly updated and verified.

In the case of the buyer who wishes to renegotiate payment terms, this request can then be reflected in the loan between Lender C and Company B (using our original example). If Buyer A needs an extra 30 days, the dynamic invoice can reflect this and then Lender C would be able to negotiate an appropriately higher fee for the loan. It all works within one open, transparent, verified ecosystem.

Another great advantage to building the invoice financing system on the blockchain is the ability to segment out the invoices and loans themselves. Let's say that a company has an invoice for $1 million. As an average investor, you may not be able to loan out $1 million on your own. But when your resources are pooled with other investors on the same platform, you can lend out that money collectively and all reap the rewards of your proportionate piece of the pie.

Fragmented invoice loans make it much easier for investors to invest as little or as much of their own funds as they'd like. This also eliminates the bidding wars among investors that would normally occur with invoice financing, because investors can lend out the money collectively. Everyone, regardless of capital, can have easy access to diversified loans for mitigated risk and optimal returns. Your average investor can have access to the same opportunities as large lending houses, albeit on a smaller scale. This can be a great way for regular people to make some extra income.

Financing the Future of Business

By utilizing a decentralized, peer-to-peer platform for invoice financing where buyers, sellers and investors are all connected together, companies like the ones mentioned above really are demonstrating what the future of business can look like. Companies improve their cash flow with accelerated invoice financing, investors earn higher rates of return and more diversified portfolios, and buyers can receive extended payment periods and even earn rewards for verifying invoices.

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