What is invoice finance?

Cashflow issues can cause major problems for small businesses. With invoice finance, you can plan for the future by raising capital against your unpaid invoices

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You have suppliers to pay, debts to settle, and more importantly, big plans to invest in.

But your cashflow is drying up because of late payments from clients. What can you do?

Have you considered invoice finance?

Invoice finance involves selling your unpaid invoices to a third party, which advances you some of the cash tied up in those invoices for a small fee.

Below, we’ll explore the different types of invoice finance available, the costs involved, and explain how you can pick a suitable provider for your business.

What is invoice financing?

Invoice finance is a flexible loan secured against your unpaid invoices.

An invoice finance provider will advance you up to 95% of the value of an unpaid invoice.

When this invoice is settled by your client, your provider will collect the balance from you, along with a small fee.

There are two main types of invoice finance: invoice factoring and invoice discounting.  See below for an explanation of how each one can benefit your business.

Why use invoice financing?

Invoice finance is one of the most affordable and accessible forms of funding for growing businesses – and it’s not hard to see why.

Instead of waiting up to 90 days to receive payment from tardy clients, you can unlock capital straight away.

Am I eligible for invoice finance?

As a general rule of thumb, if your business sells on credit, has a good spread of debtors, and boasts growth potential, you are likely to benefit from invoice finance.

Some providers may stipulate that your turnover is above a certain amount to justify the fees involved.

To obtain invoice finance, your business must be raising invoices where the goods or services have been delivered prior to an invoice having been issued to the customer.

Choosing an invoice financing provider

Don’t always choose the provider that will lend you the most money. It’s more important to know how reliable the provider’s systems are, and how they will deal with your customers.

You’ll also be talking to your provider everyday, so ensure you feel comfortable with them and that they understand your business. Make sure they aren’t looking after so many clients that you will be just a number, and ensure that you will have fast, easy contact with the right person.

Before you sign anything, check the contract thoroughly. Some providers stipulate that you only get out of the contract on an anniversary date – not one day earlier or later.

And while a provider might dangle a 90% advance figure in front of you, check that there are no hidden restrictions, such as credit insurance obligations.

If you’re considering invoice finance for your construction or recruitment business, then make sure to check out our in-depth guides to construction finance and the best recruitment factoring companies.

Or, let us help you choose an invoice finance provider! Take just two minutes to use our invoice finance comparison tool to start comparing invoice factoring quotes now – for free. 

Invoice factoring and invoice discounting

What is invoice factoring?

Invoice factoring involves actively selling your invoices to a finance company, sometimes known as a ‘factor’.

They will then advance you the money you are owed, before collecting the invoice themselves. Once the invoice is paid, you receive the outstanding balance minus the fees.

With invoice factoring, you tend to self-select which invoices to hand over to the finance company. They then take over the administration, and are effectively the credit manager for those invoices.

Invoice factoring tends to be quite flexible – you are in control of which invoices you factor, and qualifying criteria are generally easy to meet. Fees are charged on an invoice-by-invoice basis. Find out about other benefits on our invoice factoring advantages page.

How does factoring work? 

  1. Invoice your client in the usual way
  2. Sell and assign the invoice to the factoring company – ensure you are happy with the terms of the agreement (including the fees)
  3. You will then be advanced the bulk of the invoice amount (usually around 80%)
  4. From here you can use the advance as needed, whilst you and the factoring company wait for the actual invoice to be paid
  5. Once the invoice is paid, the outstanding balance (or reserve) is forwarded to you, minus the fees

These steps may vary slightly, but this is the general framework.

What is invoice discounting?

Invoice discounting is a variation on invoice factoring. The lender still advances money on your invoice, but instead of the lender collecting the debts, you collect your debt from your client.

This means that the cash advance can be higher than factoring, with a smaller fee for borrowing. However, there is still usually a monthly fixed charge on the percentage of your turnover for processing. If you stop using the facility, you will still be paying the monthly charge.

Some businesses also prefer invoice discounting over factoring as the process can be kept confidential. None of your customers need to know that you are borrowing in this way.

This allows you to be even more flexible in offering credit to your customers without impacting on your customer relations, as no third party is involved in negotiations.

It does, however, mean that you have to pay a fee without handing over any of the responsibility for your debt collection.

You should also be aware that, usually, only invoices that are 90 days or older will be accepted.

How does invoice discounting work?

  1. You raise and submit the invoice, and send a copy to the invoice discounter.
  2. The lender then pays you a percentage advance of the total value of the invoice. This value is usually around 80-90% of the invoice, but depends on what is offered to you by the lender and what advance you want to take.
  3. You then chase and collect the money your customer owes you, before depositing it into a client account with the discounting company.
  4. Finally, the invoice discounter pays you the remaining balance of the invoice (the 10-20%), minus a small fee for borrowing charges

What is the cost of invoice factoring and discounting?

Fees for invoice factoring and discounting are usually a percentage of the value of the invoice (usually between 0.5% and 5%). But they can vary from one provider to the next.

Because of this, it’s essential you negotiate and shop around for competitive quotes.

The main factors that will influence the cost of invoice finance are:

  • The value of the invoice – fees will be proportionally higher or lower for larger or smaller invoices respectively
  • Frequency of use – generally, the more invoices you release funds from through the same provider, the lower the fees
  • What sector you operate in – some sectors are inherently more risky than others, and will incur higher fees as a result
  • The reliability of your clients – the invoice finance provider will charge lower fees for established firms with a good track record of paying on time
  • The size of your business – specifically with invoice discounting, providers prefer businesses with a larger turnover, and that have good credit control processes

Our article ‘How much does invoice factoring cost?’ breaks down the various possible fees you could be subjected to, and gives an indication of the kinds of rates you can expect.

Invoice factoring and invoice discounting: which is best for my business?

The size of your business is likely to be your main consideration when deciding whether invoice factoring or invoice discounting is best for your business.

Invoice finance is generally better for smaller businesses with limited credit control and payment collection facilities. This is because the provider bears the responsibility of chasing and collecting payment. However, they will take a slightly larger fee, and may insist that you take out insurance.

Invoice discounting is generally better for larger businesses with the resources for debt collection. In fact, many invoice discounting providers will only work with businesses with a turnover of £100,000 and a positive balance sheet. Discounting is also a better option if you want to use the service anonymously, and not make customers aware you’re borrowing against their invoices.

Pros and cons of invoice factoring and discounting

To decide which is best for your business, the table below provides a detailed breakdown of the pros and cons for invoice factoring and discounting.

Invoice factoring pros and cons

The factoring provider will do the chasing for you, giving you more time to focus on your businessYou will be paying larger fees
The factoring provider may be able to negotiate better payment termsYour customer will be aware that you’re borrowing against their invoices
Your customer may prefer to deal with you directly

Invoice discounting pros and cons

Invoice discounting can offer a higher advance than factoring
Usually a monthly fixed charge on percentage of turnover
Smaller fee for borrowing
You’ll still pay the monthly charge even if stop using the facility
Confidential – your customers don’t need to know you’re using it
You’ll incur fees while retaining responsibility for debt collection
You can offer credit to your customers with greater flexibility
No impact on your customer relations
No third party involvement in negotiations

Visit our invoice finance provider comparison tool to start comparing invoice factoring quotes now

Export factoring

Export factoring is a type of invoice finance used for international trade. In this case, small businesses can receive an advance on invoices for goods they have shipped overseas.

Because international payments can take up to 180 days, export factoring enables you to free up cashflow and grow your business while waiting for international clients to pay.

There are two types of export factoring:

  • Discount factoring – the fees are based on the amount and time that the facility is used
  • Collection factoring – the cost is fixed and depends on the destination, volume of sales, and paperwork involved

Export factoring can also encompass credit protection to mitigate the risk of non-payment from a customer. Credit protection covers your business in the event that a customer pays late, or becomes insolvent and cannot pay at all.

Invoice finance FAQs

Understanding invoice finance can be difficult, so don’t worry if you still have some burning questions about it.

In this section, we’ve tried to respond to as many of these FAQs as possible with the information that small business owners or managers might need.

Can invoice finance improve my cash flow?

Yes. The primary purpose of invoice finance is to provide you with cash, quickly, when you need it.

Are there alternatives to invoice finance?

Yes. You could use your bank overdraft, take out a business loan, or use invoice financing. However, you may not be eligible, or able to raise cash quickly enough these other ways.

What can I use the advance for?

You choose what business activity you use the advance for. It may be to buy resources to meet a new order, or to make some business repairs.

What if my customer doesn’t pay their invoice on time?

This is a factor you should consider when deciding which type of invoice finance to go for. Some arrangements are non-recourse, meaning you won’t be liable for paying back the advance.

Can I use invoice finance for just one invoice?

Yes. This is called spot factoring. Alternatively, you can have an ongoing arrangement with a factoring company on a contract basis.

How quickly do you get the money?

Once your business and invoice have been approved, you can receive the advance in around 24-48 hours.

Does it matter which invoices I choose?

Yes. It wouldn’t be worthwhile to send over an invoice from a customer who always pays ahead of time and is reliable.

Similarly, it may prove an expensive risk to factor an invoice for an unreliable customer with a poor credit check. You may find additional costs coming back to you at a later date.

Will my customer know I am using invoice finance on their invoice?

As discussed above, invoice discounting allows you to remain anonymous. But it’s also possible for an invoice factoring company to operate in your business name, and to use your standard invoice collection procedures.

How much does invoice finance cost?

Invoice finance fees are charged on an invoice-by-invoice basis. To see more information about the costs of invoice and debt factoring, see How much does invoice factoring cost?

Compare invoice factoring quotes

The information on this page should help you to understand what invoice factoring could mean for your business. for more information – and for a more detailed idea as to what your invoice factoring agreement will look like – you should speak to a supplier today.

To speak to up to four trusted invoice factoring suppliers and compare their quotes, take two minutes to use our invoice finance comparison tool. Comparing quotes in this way is free, quick and easy, and it could help your business to save both time and money

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