Invoice finance is one of the most effective ways for businesses to improve cash flow and sustain growth.

Our comprehensive guide to invoice finance aims to provide an in-depth understanding of this financial tool, its various forms, eligibility criteria, costs, and potential risks.

Whether you are a small business owner, an entrepreneur, or a limited company director, this guide will help you figure out whether it’s a good fit, what to look out for, and how to obtain the best deals.

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What is Invoice Finance?

Invoice finance is a financial solution that enables businesses to unlock the value of their outstanding invoices by receiving immediate cash advances from a third-party finance provider. Instead of waiting for clients to pay their invoices, which can often take 30, 60, or even 90 days, businesses can use invoice finance to access a significant portion of the invoice value upfront. This helps improve cash flow, reduce the impact of late payments, and provide working capital for daily operations and growth initiatives.

In the UK, invoice finance has become an increasingly popular alternative to traditional financing options like bank loans and overdrafts, as it offers a more flexible and accessible solution for businesses in need of cash flow support. It caters to a wide range of industries, including manufacturing, wholesale, construction, recruitment, and professional services.

Invoice finance can be structured in various ways depending on the specific needs of a business, with the most common types being invoice factoring and invoice discounting. Both methods provide businesses with access to funds tied up in their accounts receivable but differ in terms of the level of control over the sales ledger and the involvement of the finance provider in the collection process.

Pros and Cons of Invoice Finance

Pros

  1. Improved cash flow: Invoice finance provides immediate access to funds tied up in unpaid invoices, allowing businesses to maintain steady cash flow and cover operational expenses.
  2. Flexible financing: Invoice finance grows with your business, providing access to more funding as your sales and invoice volumes increase. This scalability makes it a suitable option for growing companies.
  3. Faster funding decisions: Approval for invoice financing is often quicker than traditional loans because it relies on your customers’ creditworthiness rather than your own, providing faster access to funds when needed.
  4. Reduced payment risk: Invoice finance can help manage the risks associated with late payments or defaulted invoices. In the case of invoice factoring, the finance provider may handle collections, and some offer non-recourse factoring, which can provide protection against bad debts.
  5. Focus on core business activities: By outsourcing the credit control and collections process to an invoice finance provider (in the case of factoring), businesses can concentrate on their core activities, such as sales and customer service.

Cons

  1. Reduced profit margins: Invoice finance involves fees and charges, so it may reduce your business’s overall profit. It’s crucial to weigh the cost of invoice finance against the benefits it provides in terms of cash flow and growth opportunities
  2. Customer perception: If you opt for invoice factoring, your customers will be aware that you are using invoice finance, as the factoring company manages your sales ledger and handles collections. This could potentially impact their perception of your business’s financial stability and affect your relationships with them.
  3. Retained liability: Depending on the type of invoice finance arrangement, your business may still be liable if your customers fail to pay their invoices. This could impact your cash flow and financial stability, making it essential to assess the creditworthiness of your customers before entering into an invoice finance agreement.
  4. Dependency on finance facility: Your business may become reliant on the invoice finance facility, making it challenging to transition back to traditional cash flow management methods or switch to alternative financing solutions.
  5. Hidden costs and charges: Be cautious about hidden fees and charges in lending agreements, as these can increase the overall cost of invoice finance. Ensure you clearly understand all fees and charges associated with the financing arrangement before committing to a provider.

Types of Invoice Finance

Several types of invoice finance are available in the UK, each designed to cater to businesses’ unique needs and preferences. The most common types are:

Invoice Factoring

Invoice factoring involves selling your outstanding invoices to a factoring company, which then takes responsibility for collecting the payment from your customers. The factoring company provides an initial cash advance, typically between 80% to 90% of the invoice value, and the remaining balance, minus the factoring fees, is paid to your business once the customer settles the invoice. This method is particularly suitable for small and medium-sized enterprises (SMEs) that may not have the resources to manage credit control and collections effectively.

Invoice Discounting

Invoice discounting is similar to invoice factoring in that it provides immediate access to a percentage of the invoice value. However, the main difference is that your business retains control over the credit control and collection process. The invoice discounting provider remains invisible to your customers, meaning they are not aware that you are using this financing method. Once the customer pays the invoice, the discounting provider releases the remaining balance, minus their fees. This option is more suitable for larger businesses with established credit control processes.

Selective Invoice Finance

Also known as single or spot factoring, selective invoice finance allows businesses to choose specific invoices to finance rather than an entire sales ledger. This type of invoice finance offers greater flexibility, as businesses can opt for this solution on an as-needed basis without committing to a long-term contract.

Confidential Invoice Discounting

Confidential invoice discounting works similarly to invoice discounting, with the added benefit of keeping the financing arrangement entirely confidential from your customers. In this case, your customers will still make payments to your company’s bank account, and the financing provider will not be disclosed. This option is often preferred by businesses that wish to maintain complete control over their customer relationships and protect their reputation.

Construction Invoice Finance

This type of invoice finance is specifically tailored to the construction industry. It caters to the unique challenges faced by construction companies, such as lengthy payment terms, complex contracts, and project-based work. Construction invoice finance allows businesses to access funds based on their invoices for completed work or milestones, ensuring they have the cash flow to cover costs and keep projects moving forward.

Import Finance

Import invoice finance is designed for businesses involved in importing goods and services. This type of invoice finance helps companies cover the costs associated with importing products, such as shipping, customs duties, and taxes, by providing advances against outstanding invoices. This can be particularly beneficial for businesses with international suppliers and customers, as it helps bridge the gap between paying for goods and receiving payment from customers.

Export Finance

Export invoice finance is a variation of invoice finance specifically aimed at businesses that export goods and services. This type of financing helps companies overcome the cash flow challenges that can arise from exporting, such as longer payment terms and currency fluctuations. Export invoice finance provides businesses with access to funds based on their outstanding export invoices, ensuring they have the cash flow to continue expanding their international operations.

How Does Invoice Finance Work?

Invoice finance operates by providing businesses with immediate access to funds tied up in their outstanding invoices. The process typically follows these steps:

  • Issue invoices: When your business provides goods or services to a customer, you issue an invoice as per usual, detailing the payment terms and due date.
  • Submit invoice details: You then submit the details of the invoice to the invoice finance provider. The information required may vary depending on the provider, but it generally includes the invoice amount, customer details, and payment terms.
  • Advance payment: The invoice finance provider reviews the submitted invoice and, upon approval, advances a percentage of the invoice value to your business. The advance rate typically ranges from 80% to 90% but may vary depending on the provider and your industry.
  • Customer payment: Your customer pays the invoice according to the agreed-upon payment terms. In the case of invoice factoring, the customer pays the invoice finance provider directly. For invoice discounting, the customer pays into a designated trust account managed by the finance provider or into your own business account, depending on the arrangement.
  • Balance and fees: Once the customer pays the invoice, the invoice finance provider releases the remaining balance (minus their fees) to your business. The fees usually include a service fee (a percentage of the invoice value) and a discount charge (similar to interest on a loan) based on the time it takes for the customer to pay the invoice.
  • Repeat as needed: You can continue to submit new invoices to the invoice finance provider as you issue them, creating a revolving line of credit. This ensures that your business maintains a steady cash flow and has access to working capital whenever needed.
invoice finance image in lime green

How Much Does Invoice Finance Cost?

Understanding the costs, fees, and charges associated with invoice finance is crucial, especially since the industry remains unregulated in the UK. To make informed decisions and avoid hidden fees, it’s essential to familiarise yourself with the typical charges levied by invoice finance providers. The primary costs associated with invoice factoring and discounting are as follows:

Service Charge

The service charge covers invoice finance management, collections, and administration costs. It is calculated as a percentage of your company’s gross turnover. Service charges typically range from 0.75% to 2.5%, depending on the provider and their service level. When comparing providers, ensure you clearly understand what services are included in the service charge.

Discount Charge

The discount charge functions similarly to the interest payments on a business loan. This fee is charged on the advanced funds and generally ranges from 1% to 3% above the base rate. The discount charge is calculated daily, following the advance of the funds, which means the total cost will increase if your customer takes longer to pay.

Discount charges are usually paid either weekly or monthly, depending on the preferences of the lender. Some providers may offer more competitive rates or tiered pricing structures based on the volume of invoices financed or the duration of the financing arrangement.

When selecting an invoice finance provider, it’s crucial to carefully review and compare the fees and charges associated with each option. Be sure to clarify any potential hidden costs, such as minimum fees, termination fees, or additional charges for credit checks and other services.

Read our longer article on invoice finance costs here.

Is My Business Eligible for Invoice Finance?

To determine whether your business is eligible for invoice finance, consider the following basic requirements and criteria that most providers look for:

  1. Business-to-business transactions: Your business should primarily trade with and invoice other businesses (B2B) rather than consumers (B2C). Invoice finance providers typically focus on supporting B2B companies due to the nature of their transactions and payment terms.
  2. Legal structure: You should operate as a limited company or a limited liability partnership (LLP) in the UK. These structures offer a level of legal protection and financial separation between the business and its owners, which finance providers prefer.
  3. Credit terms: Your business should offer industry-standard credit terms to its customers. Invoice finance providers will assess your customers’ payment terms and creditworthiness to determine the risk associated with financing your invoices.
  4. Invoice volume: Some lenders may require a minimum number of invoices to be sent per month or a minimum invoicing value to consider providing invoice finance services. This requirement ensures that there is a consistent cash flow for both your business and the finance provider.
  5. Minimum turnover: Many invoice finance providers have a minimum annual turnover requirement, often around £50,000 or more. This threshold ensures that your business has an established revenue stream and is generating sufficient sales to support the invoice finance arrangement.

Is Invoice Financing a Good Idea?

The essential benefits of invoice finance are as follows:

  • Flexibility: Invoice finance solutions offer more flexibility compared to traditional business loans or overdrafts, as they are based on your outstanding invoices and adapt to your company’s sales performance.
  • Speedy decisions: Approval for invoice financing is often faster than traditional loans because it relies on the creditworthiness of your customers rather than your business. This can be particularly beneficial when you require quick access to funds.
  • Scalable funding: Invoice financing grows in line with your company’s turnover, ensuring that the funding available matches your business’s evolving needs and supports its growth.
  • Higher borrowing potential: Invoice financing typically allows for a greater level of borrowing against your assets compared to other financing options, providing your business with more working capital to cover expenses and invest in growth initiatives.
  • Mitigating payment risks: Invoice financing can help reduce the risks associated with late payments or defaulted invoices. Depending on the type of invoice finance, the provider may handle collections, and some may offer non-recourse factoring, which can provide protection against bad debts.

What are the Risks of Using an Invoice Finance Company?

While invoice finance can provide numerous benefits, it’s essential to consider the potential risks associated with using this financial solution. Some of the key risks include:

  1. Reduced profit margins: Since invoice finance involves fees and charges, your business’s overall profit may be reduced. It’s crucial to weigh the cost of invoice finance against the advantages it provides in terms of cash flow and growth opportunities.
  2. Retained liability: Depending on the type of invoice finance arrangement, your business may still be liable if your customers fail to pay their invoices. This could impact your cash flow and financial stability, making it essential to assess the creditworthiness of your customers before entering into an invoice finance agreement.
  3. Dependency on finance facility: Your business may become reliant on the invoice finance facility, making it challenging to transition back to traditional cash flow management methods or switch to alternative financing solutions.
  4. Hidden costs and charges: Be cautious about hidden fees and charges in lending agreements, as these can increase the overall cost of invoice finance. Ensure you have a clear understanding of all fees and charges associated with the financing arrangement before committing to a provider.
  5. Customer perception: If you opt for invoice factoring, which involves the finance provider managing your sales ledger, your customers will be aware that you are using invoice finance. This could potentially impact their perception of your business’s financial stability and affect your relationships with them.

What is the Difference Between Invoice Financing and Factoring?

Invoice finance is an umbrella term that encompasses various financial solutions focused on accounts receivable financing. It refers to the practice of providing businesses with immediate access to funds based on their outstanding invoices.

On the other hand, invoice factoring is a specific type of invoice finance. It involves selling your unpaid invoices to a factoring company (the ‘factor’) for a percentage of their value. In this arrangement, the factoring company takes responsibility for collecting payments from your customers, allowing you to receive funds more quickly than waiting for the invoices to be paid.

What is Single or Selective Invoice Finance?

While many invoice finance providers offer solutions that cover an entire sales ledger, it is also possible to arrange financing for individual invoices. This option is known as single or selective invoice finance.

Also referred to as spot factoring or selective invoice discounting, this type of invoice finance is ideal for businesses that rely on fewer, high-value invoices. In such situations, late payments can put an otherwise profitable business in a critical financial position.

Single or selective invoice finance allows businesses to choose specific invoices to finance, providing immediate access to funds without committing to financing their entire sales ledger. This flexibility can be beneficial for companies with seasonal or irregular cash flow needs or those that prefer to maintain more control over their finances.

Read more about selective invoice discounting, or spot factoring.

Is Invoice Finance Regulated in the UK?

Currently, the asset-based financing industry is not regulated by the Financial Conduct Authority (FCA) in the UK.

Because of this, borrowers should exercise all due diligence when it comes to researching potential providers. Pay particular attention that:

  • you’re not being tied into a contract of longer than 12 months
  • that all applicable fees are clearly stated
  • the contract should include a clear termination clause
  • Termination fees should never exceed 2 months’ minimum service fees

Bad Debt Protection

Bad Debt Protection is a credit control bolt on which you can add to an invoice finance facility. A form of trade credit insurance, this means that the factor assumes responsibility should your client default on their invoice.

As part of an overall credit management facility, it can be useful, especially for businesses in high-risk areas. It is also possible to apply bad debt protection to a specific invoice.

Learn more about invoice protection or credit insurance.

Why has Invoice Financing Achieved Such Success?

There are some reasons, but a key driver is an increase in the number of late-paying companies. The total amount of unpaid invoices is around £67.4bn, and this amount has been rising year on year for some time. It’s more common now for larger companies to use smaller companies’ cash-flow to support their own. This theory seems to have some credence when you see that 22% of all late-paying invoices are formed by large companies. The habit started during the recession and had been continued since then.

Experian reports that between Q2 2014 and Q2 2015, the percentage of SMEs waiting for payments longer than 30 days increased by 9%. 

What is Import Invoice Financing?

Import invoice finance helps businesses overcome some of the challenges of trading overseas. When a company has to pay out for goods significantly in advance of them being delivered, the time-delays can place immense strain on working capital. This specialist form of finance effectively speeds up the payment cycle by allowing the importer to raise capital before actually receiving the goods. Read our full article in import invoice finance here.

Is Invoice Finance Suitable for Small Businesses?

Unlike traditional forms of finance which require established trading records and credit ratings, invoice finance is a form of alternative finance which is suitable for small businesses and startups.

In assessing risk, the factoring company is primarily investigation the credit history of the companies owing their invoices. While preferential rates are available to businesses who do have solid credit in place, and a positive business reputation, the basic mechanism whereby factoring can improve the cash-flow cycle works exactly the same for any size of business.

Alternatives to invoice finance

There may be several finance options available as alternatives to your business depending on your circumstances. Some business owners consider types of finance such as bridging loans, peer-to-peer, secured and unsecured business loans. Please research the options available to you on our site and get in touch to find out more.

Which are the Best Invoice Finance Companies?

We have asked every single one of our providers to create some content outlining their strengths. We hope the following will prove useful to help you research your decision. You can read the article here.

We have produced this infographic to help you understand the process.

Invoice finance

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Invoice Finance FAQs

What are the Benefits of Invoice Finance?

Invoice finance can help businesses access working capital that is tied up in unpaid invoices. It allows businesses to receive payment for their invoices sooner rather than waiting for their customers to pay on their usual payment terms.

Is Invoice finance Regulated?

The invoice finance industry is not currently regulated in the UK which means you should choose a provider carefully, or work with a broker you trust.