Invoice finance explained
What is invoice financing?
Invoice finance is a short term funding option that allows you to unlock the value of a customer's invoices by receiving a percentage of their value in advance of their payment date. This type of finance is generally only suitable for businesses that invoice larger companies for goods or services.
Invoice financing allows you to borrow money that you are due to be paid in advance, in exchange for a percentage of the total sum. The amount you are charged for this service varies based on the profile of the customer you are invoicing and how much you intend to borrow, but could be as low as 10%.
Quick invoice finance facts
- A way to use your pending customer invoices to get cash before they actually pay you.
- Receive up to 90% of their value in an upfront payment. You'll pay a fixed fee for this service.
- You may be responsible for repaying the full value of the invoice if your customer fails to pay.
How does invoice financing work?
Invoice financing operates as a means for businesses to unlock cash tied up in unpaid invoices. Businesses sell their outstanding invoices to a finance company, also referred to as a factor. The factor typically pays the business around 85% of the invoice value upfront. Once the invoice is fully paid by the debtor, the business receives the remaining balance, minus the factor's fees. This practice aids in maintaining cash flow, especially in instances where customers may take a long time to pay their invoices. It's a prevalent practice among small to medium enterprises (SMEs) that operate with extended payment terms.
In this example, the business is able to unlock 85% of the outstanding invoices value, paying 7.5% in fees and 7.5% in interest.
Example of invoice financing
- A graphic design company has completed a lot of work, but is waiting on unpaid invoices from their customers
- The owner is short on working capital, so they take 10 outstanding invoices totalling £50,000 and factors them for 85% of their value
- They receive the £42,500 advance from an invoice finance provider
- The finance provider then chases the design company’s customers for the value of the invoice
- The customers pay the finance provider, who collates the funds
- The designer then receives the remaining value of the invoice minus interest and a management fee.
What is recourse financing?
With recourse financing, your organisation agrees to take full liability for the invoice you've borrowed against. That means if it's unpaid by your customer then you'll be required to repay the money you have been advanced in full. The remaining value of the invoice (usually between 10% and 30%) is held in reserve by the lender until your customer has made the full payment. The interest and management fee charged by your provider are deducted from this, and the rest is transferred to you. Those fees can vary hugely depending on which provider you choose.
What is non-recourse financing?
With non-recourse financing, if your customer fails to pay their debt, your invoice finance provider will be liable for the losses incurred. This is sometimes subject to limitations, so be sure to read the small print carefully. Because invoice financing on a non-recourse basis is riskier to the lender, it's often more expensive and much more difficult to get approved for than on a recourse basis.
Invoice financing vs discounting
Invoice financing actually refers to two related, but slightly different, financial services – invoice discounting and invoice factoring. Both allow you to use your invoices as collateral to secure a credit line, but their differences are important.
Invoice factoring, also known as debt factoring, is a contract involving an invoice finance provider managing your sales ledger and collecting money owed by your customers themselves. This means your customer will be fully aware you’re using invoice finance. Using invoice factoring can free you from time-consuming invoice collection and allow you to concentrate on your business.
Most invoice finance providers want you to have a sales volume of more than £250,000 per year before they’ll consider factoring your invoices. Alternative providers, like Market Invoice will advance individual invoices on much smaller sales volumes and on a pay-as-you-go basis.
Invoice discounting is different from factoring in that your customer’s payments are directed to a trust account in your name, held by your invoice finance provider. This means your provider won’t take responsibility for collecting payment for the invoice, so your customer won’t know that you’re using invoice finance.
It is usually only available to companies which turn over more than £1 million per year. Invoice discounting permits you to maintain close ties to your customers and continue to manage your sales ledger yourself. You might prefer this if you’re worried about how your finance provider might manage the collection of your invoices.
Selective invoice finance
Selective invoice finance, often known as spot factoring, is a flexible type of invoice financing used in the UK. Unlike whole ledger invoice finance, where you are obligated to factor all your invoices, selective invoice finance allows you to choose specific invoices to factor. This means you can decide to finance only high-value invoices or those from customers with long payment terms to maintain cash flow. It's quite an beneficial option for you if you don’t want to commit to long-term contracts or if your business is seasonal. This method provides immediate funds and can be a cost-effective alternative, given that fees are only applied to the selected invoices.
Invoice financing costs
Typically, there are two main costs associated with invoice financing – the amount of interest you'll pay for advancing your invoices, and the invoice finance rates you'll pay on top of this. Interest rates for this type of funding are similar to invoice factoring and invoice discounting, and are usually between 1.5 and 3% per year above the Bank of England base rate. Management fees are paid on the total value of the invoices you advance. This is generally around 0.2% - 0.5% with discounting, and 0.75% - 2.5% with factoring.
This means invoice factoring is much more expensive than discounting. This is because the factoring provider has taken over responsibility for chasing your invoices for repayment, and takes on the extra cost of this service. You should also be wary of any additional fees the invoice finance provider might charge (see their FAQs for details).
Besides interest and management fees, are there other costs to consider?
There are a range of invoice finance rates that you might be charged when using invoice financing. Here’s a run-down of the fees you should consider:
- Set up fees: a fee that is typically charged for setting up the facility.
- Survey fees: some lenders may want to survey your business as part of their due diligence. Some lenders offer this free of charge while others charge a fee for it.
- Audit fees: lenders could require an audit of your business. It is important you understand the charges and what frequency they will take place.
- Re-factoring fees: some lenders will charge a fee on invoices that are outstanding after a certain number of days.
- Will I have to sign a personal guarantee?
- When you factor or discount your invoices, you're using their value as collateral for the advance payment. This means you usually won't have to sign a personal guarantee.
- Borrow up to £500,000
- Repay early with no fees
- From 1 day to 24 months
- Applying won't affect your credit score
What is cloud accounting?
Cloud accounting allows you to keep track of your income and expenses with real-time, accurate, and secure bookkeeping. Find out how it works.
Quickbooks Payments Integration Guide
Integrate your online payment gateway with Quickbooks for accurate and real-time reporting. When it comes to getting started, we’ve got you covered.
A management buyout (MBO) is a well-known strategy in the business world that allows the existing management team to take control of a company by purchasing either all or a majority of the company's shares from its current owners. In the UK, management buyouts have gained significant popularity as a means of acquiring and managing businesses.
Supply chain finance
Supply chain finance plays a crucial role in the success of businesses in the UK. It involves various financial techniques and solutions that help optimise the movement of goods and funds along the supply chain. By understanding the basics of supply chain finance, businesses can unlock potential opportunities and drive growth in the competitive market.
How to get a bank statement
In today's digital age, managing your finances has become easier than ever before. One essential document that every individual should be familiar with is a bank statement. A bank statement is a detailed record of your financial transactions, providing crucial information about your account activity. Let's dive deeper into understanding the importance of a bank statement and explore the different types available.