Finding the right invoice financing option for your business. 

Invoice financing can be a valuable tool for business owners. Here’s everything you need to know to make sure you use the right invoice financing option for your company. 

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

Invoice financing FAQs

How do I know if invoice financing is right for me?

Invoice financing best suits SMEs that can’t wait long for the cash tied up in an invoice to become available. For businesses that operate on tight margins, invoice financing may be a useful solution. 

If your business can afford the costs of invoice financing, then it may be worth considering.

What is the difference between invoice financing and factoring?

Invoice financing is the umbrella term used to describe both invoice discounting and invoice factoring. However, the terms invoice financing and invoice discounting are often used interchangeably.

There are several differences between invoice discounting and invoice factoring. 

Invoice discounting is when you borrow money, using your invoices as security for a loan. You’re still responsible for chasing payment, and your customers will be unaware that you’ve used the service. Because there’s less admin for the lender this service is usually cheaper than invoice factoring. 
Invoice factoring means you sell your invoices, and the provider will take control of your invoices, meaning they’ll become responsible for chasing payment from your customers. 

Is invoice financing a good idea?

Invoice financing can be a good idea for any business that wants to release money from their unpaid invoices quickly, spend less time chasing payment, or boost their cash flow. 

Remember that invoice financing isn’t designed to be a long term solution for lack of cash flow. 

Can my small business use invoice financing?

Your small business may use invoice financing, providing that it meets a few requirements. 

To be deemed eligible by most invoice finance companies, your small business will need to have an annual revenue of over £30,000 and have a trading history to prove that you’ve received payment for invoices in the past. Because of this, a new business may not be able to use invoice financing. 

In most cases, your business will also need to be B2B. 

If you meet these criteria, any business can get invoice financing, even sole traders and freelancers. 

Can I use invoice financing if I have bad credit?

It is possible to use invoice financing with a bad credit history. This is because the main criteria for approvals are based on the financial strength of your customers, their payment history, and the terms of your invoices. 

As a result, it’s unlikely that you’ll be denied invoice financing; however, if your business has a bad credit report, a provider may increase the fees and rates you’re offered, making the service more expensive. 

When applying to use invoice financing, your personal credit history shouldn’t be a factor; instead, your business’s credit history will be checked.