Both invoice financing and letters of credit (LCs) are popular tools in trade finance, but they serve very different purposes. Here’s a clear comparison to help you understand their differences, advantages, and use cases:
🔹 1. Definition
Invoice Financing
Letters of Credit (LCs)
A type of working capital loan where businesses use their accounts receivable (invoices) as collateral to get early payment from a lender.
A payment guarantee from a bank on behalf of a buyer, ensuring the seller gets paid once shipment and documentation terms are fulfilled.
🔹 2. Use Case
Invoice Financing
Letters of Credit
Used after a sale is made and the invoice is issued. Helps businesses manage cash flow gaps due to slow-paying customers.
Used before or during a sale to secure payment, especially in international trade with unfamiliar buyers.
🔹 3. Who Uses It?
Invoice Financing
Letters of Credit
Exporters, manufacturers, service providers—especially SMEs with large accounts receivable.
Importers and exporters involved in high-value or cross-border trade where payment risk is a concern.
🔹 4. Risk Coverage
Invoice Financing
Letters of Credit
Covers the seller’s working capital risk due to payment delays.
Covers the seller’s payment risk in case the buyer defaults or refuses to pay.
🔹 5. Involvement of Banks
Invoice Financing
Letters of Credit
Bank or financier advances a percentage of the invoice amount (usually 70–90%).
Bank acts as a guarantor of payment (issuing bank for buyer, advising bank for seller).
🔹 6. Payment Trigger
Invoice Financing
Letters of Credit
Triggered by issuance of an invoice. Funds are advanced before the customer pays.
Triggered by presentation of required documents that match the LC terms (e.g., bill of lading, invoice, insurance).
🔹 7. Cost Structure
Invoice Financing
Letters of Credit
Involves interest and service fees on the financed amount.
Involves LC issuance and negotiation charges, often higher in complex transactions.
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