Invoice Financing

What is invoice financing?

Invoice financing is a form of business funding allowing you to borrow between 75-90% of the value of an unpaid invoice, using that invoice as security for funding. 

Using invoice financing to borrow from a lender is an excellent way to access a percentage of capital tied up in invoices that aren't expected to be paid for a long time.

Invoice financing covers a broad range of financing options for your business, and there are a couple of different types of invoice financing you could choose for your business.

The amount of money you can access from invoice financing will depend on risk criteria. Regardless of the amount, this finance option can free up finance to improve cash flow, be used for investments, or pay essential bills. 

What are the different types of invoice finance? 

There are two main types of invoice funding available to most businesses: 

1. Invoice discounting
2. Invoice factoring

For many, invoice discounting is the primary type of invoice financing. Because of its popularity, when people talk about an invoice finance facility, they often mean invoice discounting. This has led to the terms invoice discounting and invoice financing being used interchangeably. 

Invoice discounting

This is where you borrow money from invoice finance companies, using unpaid invoices as equity. When you use invoice discounting, you immediately get given a percentage of the invoices' value. 

Once the customer pays the invoice, the lender will give you the remaining amount, minus any service charges. 

When using invoice discounting, your customers won’t be made aware you're using the service. This is because you'll maintain control over your sales ledger. Having this control means it's still your responsibility to chase any payments. 

Invoice factoring

Instead of using your invoices to get a loan, when you use invoice factoring, you’re selling your invoices to a factoring company, who will buy your unpaid invoices based on a percentage of its value. 

Once you sell your invoice, you'll receive a percentage of the value within 48 hours. The invoice factoring company then takes control of your invoices, meaning they'll become responsible for chasing payments from your customers. 

Because of this, when you use invoice factoring, your customers will be informed that you're using the service. 

When you use both types of invoice funding, you can either send the invoices within an entire sales ledger or choose to receive funds from specific invoices you've chosen. 

Choosing invoices to get access to funds is called selective invoice finance and can be helpful when you only want to access money from particularly large or late invoices. 

How does invoice financing work?

Invoice financing follows a formulaic process that's unlikely to differ between providers. 

1. You first issue an invoice to your customer as usual. 
2. Once the invoice has been sent to your customer, you'll also provide a copy to the lender (for invoice discounting) or to the factoring company (for invoice factoring).
3. The finance providers will then verify the invoice and ensure it's legitimate. Once complete, you'll then receive a percentage of the value of the invoice. This will be a loan when using invoice discounting.
4. You'll then wait for the customer to pay their invoice. When using invoice discounting, it's your responsibility to make sure the invoice is paid. When using invoice factoring, the factoring company will have the authority to chase your customers for payment.
5. Once the customer pays the invoice, the funds will go into a holding account that the finance provider controls.
6. The finance provider will then pay you the remainder of the invoice from this payment, minus fees. For invoice discounting, the chargeswill include the interest the loan has built up plus an admin fee. For invoice factoring, the fees will be determined by the factor rate. This is influenced by how likely your customers are to pay their invoices, coupled with the number of invoices you've sent. 

How much does invoice financing typically cost?

The cost of your invoice financing will depend on several factors. The most significant for an invoice discounting facility will be interest and the fees you'll have to pay to the lender after your customer pays their invoice. 

The interest rate you're charged will vary depending on your circumstances, but will likely fall between 1.5%-3% over the Bank of England base rate. 

There will also be fees you'll need to pay. You’ll likely pay admin and credit check fees for invoice discounting, which is when the lender charges for carrying out a background check on your business and your customers. 

Here's an example of the costs of invoice discounting:

You send one of your customer’s invoices worth £8,000 to an invoice financing provider and immediately receive 85% (£6,800). 

After 30-90 days, your customer pays the total invoice of £8000 into a trust account. From that account, the remaining amount that you didn't initially receive is paid to you (£1,200), minus any fees. 

The provider may charge an admin fee, usually around 5% of the value of the invoice. They may also charge a 3% interest rate on the loan amount. This means that your fees will be £400 + £204. When taken off the remaining £1,200, you'll receive £596. 

This is just a representative example. In truth, the cost of interest may be more because it'll accumulate and grow over time, so the longer it takes for your customer to pay the invoice, the greater the invoice discounting will cost you. 

Invoice discounting is usually less expensive than invoice factoring because you're charged less in admin fees. This is because when using invoice factoring, there's more admin involved in managing and chasing invoices on your behalf. 

Invoice factoring has a unique way of charging for the service. Learn more about invoice factoring here to get a better understanding. 

The rates you're offered will be dictated by the creditworthiness of your customers, the time they take to pay their invoices, and your business's credit history.

To find the best deal for your business, you can use invoice finance brokers. 

Who uses invoice financing? 

Invoice financing can be used by any sized business but is mostly used by small or medium-sized enterprises. This type of business financing option is used across many sectors, including construction, recruitment, and manufacturing. 

Invoice financing benefits small businesses because it helps elevate any late payment challenges and bridges payment gaps, helping you to have a consistent flow of cash coing into the business. 

To use invoice financing for small businesses, your company will need to have an annual turnover of £30,000, and your invoices need to be scheduled for payment after 14 days and before 90. 

Most invoice factoring and invoice financing companies will require you to be a B2B business.

Here's everything you'll need to provide before being accepted for invoice finance: 

• Past trading history 
• Proof that your customers usually pay within 90 days
• The finance provider will usually conduct a hard credit check on your business to determine the rates and fees that you'll be charged.

Is invoice financing a loan?

When using invoice discounting, the money you recieve is considered a loan. You're using your unpaid invoices as equity to borrow money. For this reason, you're charged interest on the amount you've borrowed. 

On the other hand, invoice factoring isn't classed as a loan. This is because the factoring company buys the invoice from you, for less than the invoice is worth.

What are the advantages and disadvantages of invoice finance? 

Pros

• Improves cash flow
• Gives you instant access to money for investments or for paying bills 
• Available for most businesses 

Cons

• Comes with various fees 
• You are liable if your customer doesn't pay
• Requires a hard credit check which will leave a record on your credit report