Invoice Factoring with Blockchain: Pros and Cons & Case Study

It feels like forever, but it’s only been 14 years since we first heard the term “blockchain.” Born in 2008, the technology has penetrated every industry, from gaming to travel, and has become the backbone of DeFi, or decentralized finance. Blockchain invoice factoring is the latest addition to the impressive list of businesses transformed by the tech.  

This piece is a primer on the application of blockchain in invoice financing. In less than ten minutes, we will explain how blockchain benefits each party involved: businesses in the supply chain and financiers. We’ll also cover the basics of its implementation and guide you through a real-life case from our portfolio.

Let’s start slow and get the lay of the land first.

Invoice Factoring with Blockchain: Pros and Cons & Case Study

“Money, it’s a gas.” This quote from Pink Floyd is especially true today when most transactions are run digitally. With the developed banking system in place, funds should be readily available and flow freely to promote business activity and growth. But it’s not always the case for small and medium-sized businesses.  

As today’s extended supply chains still bear the brunt of Covid, the risk of accumulating debt along the way is higher than ever. An end client may have up to 120 days to pay an invoice, but a business working with suppliers and subcontractors rarely has that luxury. For a steady cash flow, external financing is needed — to release funds and offset the rising cost of raw materials, energy, and labor. 

Unlike larger businesses, SMEs often can’t get access to venture capital, yet they need it just as much to operate. Invoice factoring with blockchain (also called invoice financing) steps in to remedy the situation.

Invoice factoring involves selling a company’s outstanding invoices to a third party — usually a micro-financing institution (MFI). The financier typically compensates 80% to 90% right away, then transfers the remainder minus their fee after the invoice has been paid in full.

This is what the process looks like, simplified:

1. A business invoices customers for the goods or services provided.
2. The business sells its invoices to a factor.
3. The factor verifies the invoices, runs credit checks on the business and the customers, and then approves the deal.  
4. The financier pays out the bulk of the sum to the business.
5. The factor collects the customers’ full payment after the approved period, subtracts its fee, and pays the rest of the amount to the business.

Invoice financing provides SMEs with the much-needed cash they can use to quickly reinvest into the core business or cover expenses like salaries and rent. 

Here are the main benefits of invoice factoring compared to a bank loan:

• Capital is available to small and mid-size businesses
• It’s quicker and easier to approve — no audits or escrow accounts
• Many financiers even take over chasing invoices

Naturally, this form of financing is becoming increasingly popular with SMEs. Analysts expect this thriving market, estimated at $1,946.5 billion in 2021, to reach as much as $4,618.9 billion by 2031. 

However, a few issues inhibit the industry’s further growth. Spoiler: Blockchain implementation can help overcome them all.

Pain points of the traditional factoring market

Even though the process of invoice financing is quite straightforward, it could use a few improvements. Here are some of the weak links:

• Significant time needed for approval. Yes, it’s quicker than with bank loans, but still far from perfect: 24 to 48 hours is considered a fairly good result. Not a number to be proud of in the digital age. 
• Relatively high cost of transactions. Multiple verifications required to minimize the financier’s risks and the use of intermediaries in fund transfers add to the factors’ operational expenses. 
• Lack of automation. Everything from filing invoices to submitting purchase and delivery documents requires time-consuming manual work. This slows down the approval process, delays payments, and opens space for errors.
• Confidentiality-related issues. For various reasons, SMEs and MFIs are reluctant to share information that could speed up invoice validation, and there’s no centralized authority with managed access to such data.
• Possibility of fraud. Factors with a high volume of invoices have a hard time following the paper trail. The inability to reliably verify the identities of the buyer and seller is a major issue. Resorting to random checks, they risk financing fraudulent invoices. Also, some invoices may have already been factored — a phenomenon called “double pledging.”
• Compliance restraints. It’s no secret that financial institutions must comply with a number of regulatory requirements. KYC (know-your-client) procedures and AML (anti-money laundering) checks increase the cost of transactions. And don’t forget cross-border payments.
• No real-time tracking of invoices. Currently, no tools for traditional invoice factoring can offer tracking the invoice status in real time. This creates communication delays and impairs decision-making. 

The combination of these issues often leads to subpar service when dealing with private financiers. For instance, they’d rather provide their services to a business with a lot of smaller customers than a few larger ones. The reason is simple: it’s best to spread your risk when you can’t quickly obtain reliable data on creditworthiness.

The added expenses of the security and credit checks can make low-value invoices less attractive for factoring companies. This further limits the options of small businesses looking for financing.

As you can see, many problems on this list are caused by poor data availability and outdated processing practices. If only there was a solution that could address these issues…

Enter blockchain.

Pros and Cons of Using Blockchain for Invoice Factoring

Can the use of blockchain tech really transform invoice factoring? It can—and it will. We’re already seeing it disrupt the lending market, and there’s no reason to believe the revolution would stop there.

To prove our point, we’ll start by examining the internal mechanics of blockchain-based invoice factoring.

Sidenote: read this article to learn more about blockchain and its integration into business processes.

How invoice financing works with blockchain

A quick reminder: blockchain is essentially a distributed digital ledger where transactions are recorded on multiple nodes (computers) in a secure and immutable manner. One of its main benefits is the ability to use smart contracts — code that can self-execute when predefined conditions are met.

The utility of blockchain for the invoice financing market mostly comes from the following qualities:

• Data availability
• Transparency 
• Security
• Automation

Here’s what a typical invoice financing transaction may look like with the addition of blockchain tech: 

1. All parties — the buyer, the seller, and the factor — use a digital ledger that stores their information and utilizes smart contracts to define the rules of the game.
2. When the buyer and the seller agree on the contract terms, the invoices are tokenized — turned into records on the blockchain. From this moment on, these records can be accessed and tracked by parties with the necessary privileges.
3. The factor can easily verify the authenticity of the invoices, as blockchain is transparent and immutable. This can instantly prevent double pledging and fraud.
4. Just as easily, the identities of the buyer and seller, as well as their credit history, can be checked on the blockchain ledger. No need for lengthy approval procedures, as all the relevant information is readily available.
5. Independent nodes on the blockchain will oversee the transaction, and smart contracts will automatically trigger actions when respective terms are fulfilled. 
6. The transfer of funds and the reception of goods are instantly recorded and become blocks on the chain, easy to access and trace. None of the records can be changed accidentally or on purpose without the parties’ consent.
7. If the factor uses an integrated blockchain-based payment ecosystem, the funds move momentarily and without intermediaries. The result? Lower transaction costs and better value for the client.
8. When the invoice is paid in full, funds are automatically transferred to the client’s and factor’s accounts (thanks to smart contracts).

To sum up, integrating blockchain into invoice factoring can streamline every aspect of the B2B financing process. Let’s zero in on how each participant can benefit from the technology.

The advantages of invoice financing with blockchain technology

Naturally, some of the benefits will overlap. For convenience, we’ll look at it from both angles.

Benefits for factors

Micro-financing institutions stand to gain a lot from using the blockchain technology:

• Real-time processing. Due to data availability and process automation through smart contracts that blockchain brings to the table, MFIs can streamline routine operations and process invoices in real time.
• Simpler regulatory and security checks. With the buyer’s and seller’s credit histories recorded in a shared digital ledger, approval takes seconds instead of days. This will drastically improve risk profiling. In addition, smart contracts will take care of KYC and AML procedures automatically.
• Faster and cheaper payments (including cross-border). With blockchain’s potential for payment systems, factors can move funds directly while fulfilling conditions for cross-border transfers.
• Lower market entry barrier. With lower costs of transfers and no need for background checks, MFIs can finance smaller businesses, which wouldn’t have been feasible before due to low margins.
• Higher security. The use of blockchain in invoice factoring can prevent fraud and double pledging, the two biggest risks for financiers in this industry. The clients’ sensitive data will also be protected. 
• Improved profitability. These improvements and optimizations will inevitably have a positive combined effect on the ROI of invoice factoring companies.

In turn, these advantages will ensure a better quality of service for SMEs.

Advantages of blockchain in factoring for businesses

SMEs make up the main consumer base of invoice factoring and could profit the most from blockchain invoice factoring. Businesses in need of liquid cash will enjoy the following perks:

• Even lower cost compared to traditional invoice financing. Thanks to blockchain-powered transfers and simpler regulatory procedures, factors will be able to offer lower fees. 
• Quicker approvals. With the history of receivables available on the blockchain, time-consuming credit history checks will become history.
• Less paperwork. The use of blockchain will facilitate the move to a fully electronic document flow. 
• Better security. The decentralized architecture and distributed data model ensure data security in transit and at rest. 

With so many perks to enjoy, it almost looks too good to be true. For the sake of objectivity, we need to inform our readers of the possible drawbacks. 

The drawbacks of using blockchain for invoice factoring

Most of the hurdles with implementing blockchain in factoring solutions stem from two sources:

• Lack of common standards. To fully unlock the power of blockchain across the factoring industry, universal standards must be adopted. This will boost interoperability, allowing B2B payments and data exchange on a much larger scale. However, the solutions that can be built today will meet the demands of most MFIs and SMEs with extended supply chains.
• Failure to properly implement the technology. Creating blockchain-based factoring solutions requires relevant expertise both in blockchain and fintech. Otherwise, you risk paying for a product that will formally use the tech but won’t create any added value.

Which brings us to our next point. What do you need to focus on when building a solution for invoice factoring with blockchain?

We are experienced enough to handle any problem you meet on your way to invoice factoring with blockchain

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On the way toward your blockchain factoring solution

So you’ve weighed the pros and cons and made your choice: whether to implement blockchain in the factoring industry or not. Now it’s time to work out the details. We can’t possibly cover every little nuance, but a couple of key points should be singled out.

Importance of a vision

Before you invest in developing your own blockchain-based invoice factoring software, think about your goals and the challenges it should solve. The end product should address your current pain points and make the best use of blockchain.

Blockchain is uniquely versatile when it comes to optimizing business processes. Want complete transparency across your supply chain, with every document easily accessible at any moment? Sure! Need automated real-time processing of invoices with full reporting? Not a problem! With blockchain, you don’t have to pick your battles — in the right hands, the technology can do it all.

Even if you’re a veteran of invoice financing, inviting a software partner who’ll take a look at the situation from a different angle is always a good idea. Combining your knowledge of the industry and their expertise, you’ll be able to transform your vision into a viable product.

Once you’ve chosen your destination, it’s time to start your project’s journey. Just make sure you watch out for the bumps on the road. 

Solving technical challenges in factoring

Overall, the kinds of technical issues you’ll run into depend on the type of solution you want to build. Every business is unique, but experienced vendors are prepared to handle common problems.

These are some of them:

• Technical debt when integrating blockchain with legacy apps. At some point during the project, developers run into unresolved issues in the code inherited from the previous team. They are usually caused by taking shortcuts where more time and different approaches were needed. This is almost inevitable with legacy software and will put the skills of your current team to the test.
• Choosing the right blockchain/creating a blockchain for a particular solution. There’s a million options: private, public, and consortium blockchains, and then there are four layers for different solutions. As if that’s not enough, your software partner can build your own blockchain from the ground up. You will definitely need help with this crucial decision.  
• Managing specific compliance requirements. If you’re in the healthcare business, bound by data privacy regulations and requiring permits to procure certain medicines, you know what we mean. These rules and limitations must be reflected in smart contracts.

There are other choices you’ll have to make with the help of your tech partner: architecture, design, infrastructure, and so on. We can’t predict the exact technical difficulties in factoring you may face, but we know this: practice makes perfect, and experience counts.

Below is a brief description of a real-life case that our team has recently worked on. 

Case study from Unicsoft: Blockchain solution for invoice factoring

Our client, a children’s goods retailer with a large network of suppliers, needed a factoring platform. The company needed a modern, dynamic solution to efficiently manage invoice factoring for its supply chain.

Unicsoft created a blockchain-based factoring platform powered by Ethereum and Parity and hosted on the AWS (Amazon Web Services) cloud resources. The platform offered secure access to tokenized invoices and automation with smart contracts, combined with reliability and speed. 

The project was a glowing success and soon grew into a B2B solution that the client marketed to similar businesses. By leveraging the advantages of blockchain in factoring, our team was able to build a product that exceeded the client’s expectations and opened new avenues. 

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Factoring solution with blockchain technology

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Solving your factoring challenges with Unicsoft

With solid expertise in fintech blockchain development, the Unicsoft team can create various types of software to meet your needs. Our business analysts, architects, and developers have hands-on experience implementing blockchain in invoice factoring solutions. We know the industry’s challenges and can help you capitalize on your particular strengths and avoid setbacks. 

Here are some of the software development services we can offer:

• Create a basic invoice factoring platform
• Develop a custom-tailored invoice financing solution
• Integrate blockchain tech into your current software
• Build a debt marketplace
• Provide debt tokenization and tech support for future securitization and compliance

Conclusion

The fintech market is evolving. It will take time before blockchain-based ecosystems are adopted by financial institutions at the governmental level. But the process has kicked off, and the shift is well underway, with more players in the industry using blockchain in their daily transactions.

The market for blockchain invoice factoring is still in its nascence, and it’s a great time to find your spot in that niche. Unicsoft is ready to help with the technical side of things so you can focus on achieving your goals. 
Contact us if you need to consult on the implementation of blockchain factoring invoices or order development services.

FAQ

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