Invoice finance explained

Invoice finance helps businesses to improve cash flow, pay both suppliers and employees, and invest in growing your business faster than if you had to wait on your customers paying their outstanding invoices.

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.

What is invoice financing?

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%.

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.

Invoice finance explained

Invoce financing example 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.

Types of invoice financing

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

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 MarketInvoice will advance individual invoices on much smaller sales volumes and on a pay-as-you-go basis.

Invoice discounting

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.

How much does invoice finance cost?

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).

An invoice finance example

In this scenario a graphic design company uses factoring to unlock 85% of the value of their outstanding invoices. They receive £42,500 from a total of £50,000 in outstanding payments.

Invoice factoring example

Frequently asked questions

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 wont have to sign a personal guarantee.

iwocaPay – an alternative to invoice financing

If you’re looking to unlock the value of your customer invoices, it’s worth considering which other finance options might suit your business better.

One alternative is iwocaPay – an invoice solution that allows suppliers to get paid up front, while still letting buyers spread their payments over 90 days. If you sell products in the B2B space, you'll no longer need to wait for customers to pay your invoices, but can still attract buyers with long payment terms.

Coronavirus means that businesses are having to manage their cash flow even more carefully than before, and it has the potential to create friction between B2B businesses. Sellers are offering shorter payment terms than usual to make sure they get paid, while buyers need more time to pay due to falls in turnover. With iwocaPay, everybody wins. Why not try it today?

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Jamie Maddison has written for a range of publications including Lonely Planet, Geographical, Diplomat, and Hidden Europe.

Article updated on: 16 December 2021

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