Invoice finance

Invoice finance helps businesses bridge the working capital gap between providing goods and services to their business customers and being paid for them.  

Using the debts owed to you by your customers (represented by your unpaid invoices) as security you can gain quick access to a percentage of their value.  

In this article we’ve collaborated with UK Finance to look at what invoice finance is, the different types available to smaller businesses, and the pros and cons of its usage.

Like all financial products, it’s a good idea to seek independent financial advice to help you decide which product is right for you and your business.

What is invoice finance?

Invoice finance is when the lender uses unpaid invoices as collateral for funding, giving you quick access to a percentage of the value of those invoices quickly, usually within 24 hours.

The amount of money a provider will ‘advance’ to you is based on its own risk criteria. 

It will generally take into consideration the underlying strength of a business and its debtor book (the record of debts owed to a business by customers), with less focus on short-term financial performance. 

This means that invoice finance may be available where other lending products are either not or cannot provide the amount of funding a business requires.

Invoice finance is quite simple. 

When a business takes out an invoice finance facility, they can ‘assign’ (essentially sell), some or all of the customer invoices that are currently outstanding to the finance provider.  

The client will then have access to up to 80 or 90 per cent of the value of those invoices virtually immediately. 

The remaining 10 or 20 per cent of the value of the invoices assigned – less the finance provider’s fees - will be made available upon payment of the invoices by the customer of the client business. 

The invoices raised and assigned generate a pot of available funding that rolls over as invoices are raised and paid, creating a dynamic working capital facility that tracks growth in your business – the more business you do, the more finance will be unlocked.  

Businesses can draw down the funding you need within that availability.

A business will usually pay a service fee (a percentage of the value of each invoice), and a discount charge (like interest) based on the amount of funds it utilises. 

These methods of funding let businesses access finance for cashflow or even release funds for investment purposes, using an often-untapped asset on your balance sheet. 

The products are a good way of unlocking working capital quickly, which can be crucial for handling daily operations, payroll, and other costs.  

Invoice finance can also be used for boosting business resilience as well as helping those experiencing growth or wanting to re-structure their finances.

Terminology may vary but there are two main types of invoice finance:

Invoice factoring 

The finance provider will advance to you up to 90% of the value of your invoices almost instantly instead of waiting 30 days, 60 days, or longer for payment by your customers.

It will also manage your sales ledger and be involved in collecting payment for your invoices direct from your customers. 

Your customers are likely to know that your business is using a factoring provider.

The service fee percentage will generally be higher than an invoice discounting facility due to the additional sales ledger management support.

Some of the characteristics of factoring include:

• being generally easier for smaller businesses to secure – usually available for businesses with annual sales up to £2 million.
• the factoring provider credit checking potential customers – helping you manage your risks - and providing support and expertise in sales ledger management.

Invoice discounting

This works in a similar way to factoring, in that the finance provider will lend you up to 90% of the value of your invoices almost instantly instead of waiting 30 days, 60 days or longer for payment. 

However, invoice discounting is a finance-only product, without the additional day-to-day sales ledger management and collection activity that is provided through factoring. 

This means that many invoice discounting facilities are undisclosed, so your customers won’t be aware that you are using an invoice discounting provider.  

The service fee percentage will generally be lower than a factoring facility and both products will generally offer competitive discount charges (similar to interest) due to the secured nature of invoice finance. 

Invoice discounting is more often used by more established businesses with larger turnovers, but an increasing number of providers are now making it available for smaller businesses as well.

Other types of invoice finance

In addition to factoring and invoice discounting, there are a number of other types of invoice finance available to smaller businesses.

Selective invoice financing provides you with the flexibility to finance selected customer accounts, whereas spot factoring gives you the option to finance distinct invoices.

These methods differ from factoring and invoice discounting as they will not necessarily provide finance on an ongoing basis; they offer you the choice of determining which invoices to finance while managing the remaining ones in a typical manner.  

They can be useful products for businesses that have occasional, rather than ongoing, working capital requirements.

Understanding which type of invoice financing will work best depends on your business's size, current situation, requirements, preferences, and objectives.

Who offers invoice finance?

There are lots of different invoice finance providers in the UK, ranging from specialist invoice finance companies to banks and other financial institutions.  

The majority of providers are Invoice Finance and Asset-Based Lending members of UK Finance. 

In addition, an invoice finance provider that is a member of UK Finance is required to commit to meeting the highest standards in their dealings with prospects and client businesses through an independent Standards Framework. 

This includes a Code of Conduct along with an independent complaints process. 

More details of the Standards Framework along with a list of providers can be found on the UK Finance website.

Is my business eligible for invoice finance?

As with all financial products, there are a number of eligibility criteria you will have to meet to make use of invoice finance.

Do you provide goods or services to other businesses?

Invoice finance is normally only available to businesses that trade with other businesses (known as business-to-business, or B2B) on credit terms.

A lender won't necessarily turn you down if your customers don't fall within this bracket but may offer you less finance as a result.

Are you an established business with a trading history?

A invoice finance provider will likely want to see your latest accounts along with details of your outstanding invoices (your accounts receivable) to see that you are an established business and to assess the quality of the invoices (how likely they are to be paid without any issues).

How much can an invoice finance facility generate for your business?

The amount of funds you can generate from invoice finance will depend on how much is owed to your business through your invoices. 

For example, if your business is currently owed £500,000, an invoice finance facility at 80 per cent would advance as much as £400,000 immediately, with the remaining £100,000, less fees and charges available when your customers pay. 

The percentage offered by the invoice finance provider will usually be determined by the quality of the customer businesses owing the money, and the likelihood of the invoices being paid. 

There's no minimum or maximum threshold for invoice finance, but generally a traditional invoice finance facility would not be suitable for businesses with annual turnover of less than £300,000. 

For these businesses, selective or spot invoice finance, where you can use individual invoices for occasional finance, may be more suitable.

Do your customers pay invoices within 30 to 90 days of you issuing them?

If it takes longer than 90 days for customers to pay your invoices, some invoice finance providers may not approve your application.

This is because they would have to wait too long to collect-back the money they've advanced to you.
It's worth speaking to a few lenders as each will have different terms.

What are the benefits of invoice finance?

Utilising invoice finance, like all funding options, comes with its own set of benefits and drawbacks.
Here are some significant advantages:

Maximising your assets

By using unpaid invoices as collateral for the funding, a business is able to capitalise on an often-unused asset on its balance sheet.

Asset Protection

The unpaid invoices serve as the main security for the facility, meaning generally less reliance on other forms of security, thus protecting your assets.

Flexibility

Beyond that the funding provided should be used in the running of your business, there are not normally restrictions on how you spend the money generated from invoice finance, giving your business flexibility in terms of how the proceeds are spent, be that on more inventory, staffing, or another element of the business’s activities.

In addition, an invoice finance facility should grow in real time as your sales increase, so the level of finance available should align with your cashflow needs, so long as the end customers and likelihood of payment by them remains strong.  

Quick Access

Although much like traditional bank loans, getting an invoice finance facility set up can take a bit of time, but once up and running, invoice financing can provide funds within 24 hours of new invoices being generated.  

In addition, it will continue to scale with your business so you will not need to organise new lending when you take on a significant new customer, for instance.

Scalability

As your business turnover grows, you can access more funds, thereby continually enhancing your business cash flow.

Improving cash flow

Many businesses report maintaining access to working capital as their main financial challenge, not overall profitability.  

As invoice finance can make funding available quickly and can scale with your business, invoice finance helps you manage your working capital and keep your cash flow healthy.

Efficiency

Invoice finance providers are experts in sales ledger management, and their knowledge and experience can help businesses focus on and control their invoicing process.

Companies that provide invoice factoring essentially function as credit controllers too, freeing up more of your time to concentrate on your business growth.

Retaining equity and compatibility with other lending products

Since invoice finance is a debt product you won’t have to give away equity when raising finance for your business.  

In addition, as the invoice finance provider will be focusing on the debtor book for repayment, it can work alongside other lending facilities such as term-loans, asset-based lending, and asset finance.

Learn more about working capital finance products with our helpful guide.

What are the disadvantages of using invoice finance?

While invoice financing offers several advantages, it is important to be aware of potential drawbacks as a business owner.

These include:

Administrative requirements

Invoice finance does require more active management on the part of a client than simply applying for and drawing down a loan, for instance. 

As a result, invoice finance providers will require you to enter into an agreement for a minimum period of time.

Generally speaking, though, invoice finance providers will also be unlocking greater levels of funding, and potentially at a lower cost per pound of funding than would be available from other lending products in the same circumstances. 

Technology is making the products increasingly light touch – integrating directly with business banking, accounting and invoicing platforms for instance – which in turn is making the products even more cost-effective and accessible.

Customer dependence

Depending on the terms set by your lender, you may be held responsible if your customer fails to settle their invoice. 

Many invoice finance providers offer forms of bad debt protection that can sit alongside an invoice finance facility, which can help minimise disruption if your company suffers a bad debt.

Privacy concerns

In the case of invoice factoring, the credit control process is handled externally.

This could potentially influence how your clients view your business.

However, this issue does not arise with invoice discounting which is generally provided on an undisclosed basis.

No substitute for profitability

Whilst lending can help a business cope with short-term challenges, no form of commercial finance can make a fundamentally unprofitable businesses successful in the medium and longer-term.  

Invoice finance will generally be allowing you to ‘advance’ your cashflow.  

As your turnover increases, an invoice finance facility will unlock more funding.  

However, if your turnover reduces the funding available will reduce as well.  

You will always need to be able to pay back the funding that has been advanced to you.

Costs

As with any commercial finance product, if you opt for invoice finance it is important to understand the costs involved and take into account the interest rates and processing fees levied by lenders, as well as your responsibilities under the finance agreement. 

With factoring, you should also weigh up any cost savings that can be made from outsourcing some of your processes before making a decision, as it is not just finance that you will be receiving.

Potential to affect your credit report

As with any commercial finance product, invoice finance providers will conduct credit checks when you apply for finance.

These checks could have an impact on your credit report.

How can a business access invoice finance?

You can search for invoice finance providers online.

Before you get going, use this checklist to help decide whether invoice finance is suitable for your business.