Invoice Finance, Factoring & Discounting for UK Businesses

Discover all you need to know about invoice finance, factoring and discounting, how you can improve your cash flow and keep your business finances on track.

My cash flow is not as good as it could be

Let me guess: you need finance for some reason but you’re stuck waiting for customers to pay invoices? We should have a talk about invoice finance, another popular alternative funding model for small businesses.

What is invoice finance?

The idea with invoice finance is simple. You’re waiting for customers to 

pay invoices, but you could do with the money now. With invoice finance you “sell” your outstanding invoices to a third party, who will advance you 80-85% of the money owed with the rest coming when the invoices get paid.

Tell me more about invoice finance, invoice factoring and invoice discounting.

There are two main kinds of invoice finance: Invoice factoring and invoice discounting.

With factoring, a finance company essentially manages your sales ledger and collects the money your customers owe you against outstanding invoices. You get a percentage of the total value of the invoice (often around 85 per cent) and then the remainder when the invoice is paid. In turn you pay interest - called a ‘discount charge’ - to the finance company and typically a service charge, based on turnover.

Often, when businesses sell goods or services to wholesalers or retailers, they do so on credit, meaning customers don’t need to pay straight away. The company that has purchased the goods or services is given an invoice with the total amount due and the due date. By offering this credit, the business funds are tied up. To free funds, these businesses may opt to finance their invoices.

Banks and specialist invoice financing companies will provide this short-term borrowing option to businesses using two different methods.

Invoice factoring sees the borrower sell its outstanding invoices to a lender, which might provide 70 to 85 percent up front of the value of the invoices. Assuming the lender receives full payment for the invoices, it will then provide the remaining 15-30 percent of the invoice amount.

With factoring, the lender collects payments from customers, so they will be aware that the business is using this kind of financing. This approach better suits smaller businesses without a dedicated in-house credit department and with a minimum turnover of £50,000.

Invoice financing can also be structured through invoice discounting in which the borrower collects customer payments, meaning customers are unaware of the financing arrangement.

The lender will advance as much as 95 per cent of the invoice amount. The borrowing business then repays the lender as it receives the invoice payments from customers. In comparison to factoring, discounting is better suited to established companies with in-house credit collection departments and annual turnovers of at least £100,000.

Whether you go for invoice factoring versus discounting depends on your business, as well as how your customers would perceive a third party collecting their invoice payments.

The main advantage of factoring is that your business does not need to concern itself with chasing payments, so can focus on other areas. In addition, the invoice financier will run credit checks on potential customers, making it easier to identify potential late or non-payers. And, in some cases, invoice factoring companies can negotiate better terms with debtors.

Invoice discounting, on the other hand, enables businesses to ensure customers are unaware that they are borrowing against their invoices.

Why would you use invoice finance?

Invoice finance can improve cash flow. For example, if a business is running into problems with customers taking a long time to pay or is having difficulties obtaining other types of business finance.

It can also be used to pay employees or suppliers, or to reinvest in the company. Longer term, this type of finance can just keep finances in good shape, even if customers fail to pay on time. Businesses can often receive up to four times as much cash as a traditional bank loan or overdraft would provide.

By its nature, invoice finance tends to be used in some industry sectors more than others, including construction, manufacturing, logistics, printing, recruitment, security, transport and wholesale.

Why does invoice finance help those growing business?

You need to pay your suppliers after 14 days, but your customers are paying you after 30 days. That’s a cash flow problem which isn’t going to go away and with a growing turnover, is only going to get worse. Invoice finance recognises this and is able to carry on growing in direct relation to the amount that you are owed.

What are the downsides of invoice financing?

Clearly the invoice financing companies want to make their money, so you’ll pay interest on the amount owed at any time, and usually a service charge as well. As always, make sure you read the small print and do your sums first. You will clearly sacrifice some profit.

Be aware that invoice financing is primarily designed for “business to business”. If your customers are predominantly members of the public, you will probably have to look elsewhere.

As your invoices are committed to the finance company, you may find it more difficult to find other sources of business funding, as part of your potential collateral is effectively unavailable.

What are the costs of invoice finance?

The main financial costs will be the interest charged on the amount borrowed – usually 1.5 to three per cent – although there are often additional management fees, typically 0.2 to 0.5 per cent of turnover. This obviously means that the full value of the goods sold cannot be realised.

There are also potential non-financial costs, particularly with factoring, in which customers might view the use of invoice financing as suggestive of a fundamental weakness in the business. This could cast some doubts on the continuing business relationship.

In addition, once a business has used invoice financing, it may become harder to secure financing from other sources. Businesses may also find it difficult to stop using invoice financing if they begin to rely on the steady cash flow it provides. In some cases, finance providers will tie businesses into a 12-month contract.

How long does it take to secure invoice finance?

A lender will check the credit history of the borrower and its customers, the types of invoices used, the procedures for ensuring invoices are paid (credit control) and the business plan.

All of this can be done in a matter of days but depends on the lender gaining access to the information quickly. In general, the invoice financing facility should be available within 10 working days, with businesses usually able to receive cash within 24 to 48 hours of issuing an invoice.

What type of security do I need for invoice finance?

The invoice is essentially what is used as security, with the promise of payment by the borrower’s customers deemed sufficient.

The lender’s risk is limited by not advancing the full amount of the invoice value. However, the possibility that the customer may never pay the invoice could result in a difficult and expensive process to recover the debt.

Is there anything else I need to know about invoice finance, factoring or discounting?

Let’s talk about invoice factoring again. While it may be tempting to outsource the management of your sales ledger to a third party you should think about how this affects your relationship with your customers.

The fact that a third party is managing your ledger and is trying to recover monies may affect how your customers perceive your business, especially if the company is seen as being “pushy”. You have built a relationship with your customers which you, and them, value.

In contrast, one of the benefits of invoice discounting is that your customers need never know as the financing arrangement can be made confidential. As far as your customers are concerned, they are still dealing directly with you.

While you obviously have extra leg work to do compared to a factoring arrangement, you will still manage your own sales ledger – and control the relationship with your customers.

Another potential benefit I should mention is that it can be cost effective to insure against bad debts as part of your invoice finance package

It is also possible to finance single invoices, rather than an ongoing arrangement to fund all of your invoices - this can be really handy if you have a specific or one-off need.

Or you may choose invoice discounting, manage the customer relationship while still receiving the value of the invoices from your partner.