Invoice finance

A guide to invoice finance

What is invoice finance?

Invoice finance is a flexible form of funding that businesses can use to release funds from unpaid invoices. It may also be called accounts receivable financing.

The invoices act as a kind of security, as the finance provider will lend your business a percentage of the total amount owed on the invoice, such as up to 90%. Providers can often transfer the funds relatively quickly and it means the business won’t need to wait days, or even months, for a customer to make a payment.

Once the invoice is paid, your business will have access to the remaining percentage of the invoice’s value, minus any fees and charges applied by the finance provider.

How does invoice finance work?

When you apply for any form of invoice finance, the provider will perform a range of checks to assess the risk of not being paid in full. They do this based on the volume and size of your invoices, the payment terms, the creditworthiness and payment history of your clients, the industry you are in, and your company history, among other factors.

If approved, the provider will agree the amount of money it can send you. This is usually around 75% to 95% of your accounts receivable (the money your business is owed). The provider will give you a full quote detailing the terms of the agreement and any fees that are applicable.

There are several types of invoice financing to choose from that work in different ways, as explained below.

How quickly can I access funds through invoice financing?

While invoice finance could take several weeks to set up, once you have signed your agreement, you may be able to receive your funds within 24 hours.

Depending on your agreement, your business may be tied into a fixed contract for a number of months, or it may operate on a rolling basis.

How does invoice factoring work?

When you choose invoice factoring, the finance provider takes control of your invoices. It will be responsible for collecting payment from your customers, which means your customers will be aware you are using this service (unless you choose a confidential option).

Your customers will pay the full value of the invoice to the provider. When the provider receives the payment, it will release the remaining balance to your business, after taking away the necessary fees and charges.

For example, if you agree to £10,000 of invoices to go to the invoice factoring company, it may provide you with a cash advance of 85% or £8,500. The remaining 15% or £1,500, less the discount charge and service fee, will be paid to you when your customer pays their invoice in full.

Because the financing provider is in charge of ensuring your customers pay, it may be more willing to offer this service to newer or smaller businesses. However, it is also likely to be more expensive than invoice discounting.

How does invoice discounting work?

When you choose invoice discounting, the provider doesn’t manage your invoices or chase payment from your customers. This means it’s still your business’s responsibility to ensure the invoices are paid and means your customers shouldn’t know that you are using this service.

The customer will pay the invoice to your business, usually to a specific trust account that the financing provider also has access to. The provider will deduct the agreed fees and charges, and your business will receive the remaining balance.

Invoice discounting is often reserved for more established businesses with a larger minimum annual turnover.

Selective invoice finance

Businesses can use invoice financing across their whole sales ledger for an agreed period of time, which could be useful if they need to release capital and access finance on longer-term, ongoing basis.

Alternatively, selective invoice financing allows you to borrow against individual customer accounts, while spot factoring allows you to borrow against individual invoices. This may be suitable if you have several customers that you regularly deal with or have an invoice for a particularly large sum and/or with a long payment term.

This form of finance means you won’t be tied into a long-term contract and can choose which invoices to finance, so it may be useful if you only need to use this financing option occasionally or as a one-off to cover short-term cash flow issues.

Who is invoice finance suitable for?

While invoice finance comes at a cost, it can be a useful option for businesses that:

• have a lot of capital tied up in unpaid invoices
• have few or no assets which could make it difficult to qualify for other forms of finance
• work in industries such as construction, manufacturing and logistics that issue a lot of invoices to other businesses
• often have to deal with slow or late payments from clients.

Is my business eligible for invoice financing?

A range of businesses can apply for invoice finance, but their eligibility will depend on their individual situation, the finance they apply for and the requirements of the provider.

As a minimum, your business will usually need to be trading with other businesses (not consumers) as the finance is provided on these types of invoices.

Providers will also want to see that invoices can be paid within a reasonable timeframe, usually within a maximum of 90 days. If your business has evidence of invoices being paid on-time, you will improve your chances of getting invoice financing.

The provider will conduct other checks on your business, including a credit check, to make a decision on whether to offer invoice finance and, if so, how much it is willing to lend. It may also want to look at your main customers and check their record of paying invoices.

While established businesses with a healthy turnover and good trading history are more likely to be approved for invoice finance, newer businesses and start-ups may be eligible from some invoice finance companies, depending on their circumstances.

Note that individual providers have their own eligibility criteria and may have minimum turnover requirements, for example, so you should always check this before applying for invoice finance. It may also be worth speaking to a specialist broker, especially if your situation is more complex, as they can help you find the right kind of finance for your business.

Can start-ups qualify for invoice financing?

Start-ups and newer businesses may be eligible for invoice finance, but they are likely to find it harder to be approved than larger and more established businesses. Ultimately, the decision will depend on each individual business and each provider.

Bear in mind that, if an invoice financing provider accepts an application from a newer business or smaller business with a lower turnover, they may lend a lower percentage of the unpaid invoice(s).

Smaller businesses may find it easier to be approved for invoice factoring, as opposed to invoice discounting. This is because the financing provider has more control over getting the money owed on the invoices.

Which lenders offer invoice finance?

A range of providers offer invoice financing facilities, including high street banks, business lenders and specialist finance companies.

Most major invoice financing providers are members of UK Finance, which means they need to meet certain standards in the way they conduct their business. See a list of members on the UK Finance site.

Instead of applying to a provider directly, it can be useful to speak to a broker to discuss your options to make sure you choose the right financing option for your business requirements.

How much does invoice finance cost?

Invoice finance can include some, or all, of the following fees:

• Service fee. This may be a small percentage of the value of each invoice, or as a percentage of your business’ turnover.
• Discount charge. This is a percentage of the amount loaned and will depend on how long it takes for your customers to pay their invoices.
• Early payment fees. These may apply if you have a fixed term agreed for your invoice financing and you want to end it early.

The exact costs will depend on the type of finance and your individual business situation.

Note that providers may have different names for their fees, and may apply additional charges not mentioned above, so always check the charges involved before taking out any finance.

What are the risks of using invoice finance?

The main risk of invoice finance is that your customers or clients may not pay back their invoices. Depending on whether you choose recourse or non-recourse factoring (explained below), this could mean your business needs to cover this debt and pay the invoice finance provider yourself.

Another risk of using invoice finance is that your business may become reliant on it and end up in a cycle where you use it for your everyday needs. This will be expensive and could mask some more deep-seated issues with your business finances, instead of it being a solution to a temporary issue.

What happens if your clients don't pay?

What will happen if your customers don’t pay their invoices depends on the form of finance agreement you have.

Recourse factoring

With this option, any unpaid invoices remain your responsibility and not that of the invoice factoring company. As you have already received a cash advance for the invoice, you will be liable to repay these funds to the financing provider by the agreed date (essentially buying back the invoice), even if the customer hasn’t yet paid.

This approach has the lowest risk for invoice factoring companies, so typically has the lowest costs associated with it. You may also be able to borrow more with this option.

Non-recourse factoring

With this option, the factoring company takes on the liability for any unpaid invoices. This means the factoring company will need to collect payments and shoulder any losses if a customer doesn’t pay; your business won’t need to cover any losses.

Because this option is riskier for the financing company, it often comes with higher fees and may have stricter eligibility requirements.

Will my customers know I’m using invoice financing?

This depends on the type of invoice finance you choose. If you use invoice factoring, the financing provider will manage your invoices which means your customers are likely to be aware that you are using this financing facility. The provider may sometimes run a credit check on your customers. However, it may be possible to choose a confidential service that means your customers may not need to know.

If you use invoice discounting, your business retains control of its invoices and is responsible for chasing up any payments. This means your customers shouldn’t be aware you are using invoice finance.

Does using invoice finance impact a business’s credit rating?

When your business applies for invoice finance, the provider will often run a credit check. This will appear on your credit report and could affect your rating.

As long as you stick to the terms of your agreement, invoice finance shouldn’t harm your rating and may even help it. However, if you default and don’t pay any money owed to the provider, for example, this is likely to harm your credit rating.

Alternatives to invoice finance

Invoice finance may not be suitable for all businesses. For example, if your customers tend to pay their invoices relatively quickly, the cost of invoice finance may not necessarily be worth it.

Other forms of business finance you could consider include:

• Business loan. This allows you to borrow a lump sum and repay it in monthly instalments over an agreed period.
• Business credit card. A more flexible form of short-term financing, a credit card can help you cover any temporary gaps in cashflow and pay for a range of expenses. You won’t pay any interest if you clear your balance before charges apply.
• Business overdraft. Your business bank account may have an overdraft, which could be useful if you need to temporarily borrow extra funds. However, check the terms and charges as this can be an expensive option.
• Line of credit. This is like a flexible combination of a loan and credit card as it allows businesses to borrow as much or as little money as they need, up to a maximum limit. You only pay interest on the credit you use.
• Asset finance. If your business needs certain equipment, machinery or vehicles, for example, this form of finance allows you to pay for it in monthly instalments. Depending on the type of contract you choose, it may act as a hire agreement, or you may own the item at the end of the term.

What is the difference between invoice financing and a business loan?

Invoice finance is secured against your unpaid invoices, so the amount you can borrow is directly tied to the amount you are owed.

By contrast, a business loan is a separate agreement that allows you to borrow thousands, or even hundreds of thousands of pounds, at a certain interest rate. Business loans may be unsecured or secured against property or other business assets.

While invoice finance is repaid when the customer pays the invoice, business loans are typically repaid in monthly instalments.

Benefits of using an invoice finance broker

1. A broker’s knowledge of the lenders on the market can help your business find a funding provider that offers a suitable financing facility for your requirements.
2. With so many lenders offering a wide array of funding products, it can be a time-consuming process to research and review the pros and cons of each one. A broker’s market knowledge will save valuable time and resources as they can identify which funding options and providers would be the best fit for your business’s requirements.
3. Choosing an unsuitable financing facility can prove costly for your business. Working with a broker means you’ll only be introduced to the combination that suits your business over the short, medium and long term.
4. Good invoice finance brokers may keep in touch even after they’ve found a suitable financing option for your business. They may be on-hand while you use the facility to ensure it’s running smoothly, assist with any teething issues and arrange additional, complementary funding if your requirements change.