How to log invoice financing in Xero: a guide for business owners

How to log invoice financing in Xero

Invoice financing is a quick and straightforward way to fill an urgent cashflow hole. It can be a lifesaver for cash-poor companies that have a sudden, pressing need for working capital in the business.

But once you’ve entered into an invoice financing arrangement with a provider, how do you account for the related transactions and payments in your Xero accounts?

In this post, we’ll give you the lowdown on logging invoice financing arrangements in Xero.

What is invoice financing?

Invoice financing allows your business to borrow money against the value of your customer invoices. In effect, you ‘sell’ your invoices to the invoice financing provider, they give you a percentage of the additional cash straight away (80/20 being a usual split) and the remaining percentage is paid to you once the customer pays the invoice.

There are two types of invoice financing to choose from:

  • Invoice factoring – you sell your invoices to the finance provider, the provider loans you the funds and then collects the due payments directly from your customers.
  • Invoice discounting – the provider loans you the agreed funds against the value of the invoices, you (the business) collect the due payments from your customers, then pay the finance provider.

If you’d like to find out whether invoice financing could benefit your business, visit Fluidly’s funding page.

Why is logging invoice financing so problematic?

So far, so good, right? But once you’ve sold your invoices, received the initial funds and have been paid the remaining percentage, how do you log and reconcile the transactions in Xero?

The key problem lies in the basics of your accounting records and logs transactions. When it comes to incoming and outgoing money, your finances are split into two functions:

  • Accounts Receivable – this is money that’s owed to you by your customers, so it’s where customer invoices sit. In a nutshell, this is where cash comes into the business.
  • Accounts Payable – this is money you owe to your suppliers. It’s where cash goes out of the business.

The problem is that invoice financing muddies the process of money coming in and going out of your business bank account.

Under the usual process of invoicing:

  1. You raise an invoice and send it to the customer
  2. The customer pays the amount due
  3. You reconcile the incoming payment on your statement against the relevant invoice

When you start invoice factoring, the process changes:

  1. You raise an invoice and send it to the customer
  2. You sell this invoice to the finance provider
  3. 80% of the funds are loaned to you by the finance provider
  4. You pay an agreed percentage to the provider to cover their fee
  5. 20% of the funds are paid once the debt is collected by the provider
  6. The customer pays you nothing, directly (as the money goes to the provider)
  7. From an accounts perspective, you can’t match the incoming funds against the customer invoice, as the payment and the invoice relate to two different entities.

Confused yet? We’re not surprised.

The increase in the complexity of the financial process makes it hard to know how to log, match and reconcile an invoice financing arrangement in Xero. And, as every accountant will tell you, double-entry bookkeeping requires that every accounting entry has a corresponding and opposite entry to a different account, if your Xero ledgers are going to balance.

How to log your invoice financing correctly

How can you set up your Xero accounts to properly account for the various transactions and entries that an invoice financing arrangement will generate?

There’s no one catch-all answer to this thorny problem, but the accounting partners we’ve spoken to usually work from a generic process along the following lines:

  • Set up a separate ‘dummy bank account’this new bank account represents your current account with the finance provider. Have all loaned funds paid directly into this new account, keeping your loaned cash separate to the normal cash assets in the business – two pots for two different kinds of cash.
  • Record the full payment to your dummy account – use the ‘Make a Payment’ or ‘Batch Deposit’ functions in Xero to record the full payment to your dummy account.
  • Transfer the payment to the dummy account – once the finance provider pays you the agreed funds, use the ‘Transfer’ feature to code the deposit to your dummy account.
  • Create ‘spend money’ transactions for any fees – for any interest and fees that the finance provider charges you, use the ‘Spend Money’ transaction in Xero and deduct this from your settlements.
  • Reconcile the account against the bank statement – use the ‘Mark As Reconciled’ tool in Xero to reconcile the account against the statement for the dummy account – you’ll need a full statement from your banking provider to do this effectively.

We suggest working closely with your accountant when setting up invoice financing within Xero. They will assist you with any queries and ensure your accounts are entered correctly.

Accessing additional funds for your business

At Fluidly, we help business owners sleep better by giving them confidence in their financial future. With automated cashflow forecasts, easy to use goal planning tools and funding options that provide reliable financial solutions when needed.

To find out how Fluidly can help your business access additional funds – whether you want to begin invoice financing or take out a loan – visit our funding page or get in touch with our team today.